2024-01-07 10:59:46 ET
Summary
- Automatic Data Processing has raised its dividend for nearly 50 consecutive years, showcasing its long-term profitability and ability to generate consistent growth.
- The company is a leading player in business services outsourcing, providing payroll services and human resource technology to over one million clients worldwide.
- The company's dividend history and strong profitability make it a reliable choice for dividend growth investors.
As a dividend growth investor, the overwhelming majority of the stocks I own in my portfolio are those with long histories of paying dividends. The reason for this is that companies with multiple decades of dividend growth have proven business models that work throughout all portions of the economic cycle. These companies must be highly profitable to be able to regularly grow the dividend.
Automatic Data Processing (ADP) is one such company as it has raised its dividend for nearly 50 consecutive years. This growth streak covers multiple wars, recessions, periods of high unemployment, and high interest rates, among other difficult operating environments, but company has still managed to reward shareholders with a higher dividend for almost five decades.
This has been accomplished because Automatic Data Processing's ability to increase its profitability has paved the way for it to continuously raise its dividend.
Company Background
Founded in 1949, Automatic Data Processing has become one of the leading names in business services outsourcing. The company's product offerings include payroll services, human resource technology, and various other business operations.
In the last 75 years, Automatic Data Processing has grown to be an incredible player in its industry.
Today, Automatic Data Processing provides services to more than one million clients worldwide. The company's reach is so extensive that it is estimated that the company provides payroll services to one in six workers in the U.S. and transferred more than $3 trillion to its client's employees last fiscal year.
Long Track Record of Profitability
Over the long-term, Automatic Data Processing has been a consistent growth machine. Over the last ten fiscal years, adjusted earnings-per-share have a compound annual growth rate ((CAGR)) of more than 11%. This growth rate has exceeded increases in revenue, which have a CAGR of approximately 6% over that same period.
The reason for difference in top- and bottom-line improvements is that Automatic Data Processing has become more efficient at running its business. The net profit margin has expanded 500 basis points to 19.8% from fiscal year 2014 through fiscal year 2023.
This increase in the ability to extract additional profit from each dollar of revenue is a major reason why the company's earnings-per-share figure has enjoyed a double-digit growth rate while revenue growth has been more modest.
Given this track record, it is not surprising that Automatic Data Processing receives strong marks in profitability from Seeking Alpha Quant.
The company receives at least an "A" in nearly every category covered under profitability compared to those companies in the industrial sector. Compared to most of its peers, Automatic Data Processing has been an excellent generator of profits.
This scenario of earnings growth running ahead of revenue gains played out in the most recent quarter as well. On October 25th, 2023, Automatic Data Processing released first quarter earnings for fiscal year 2024. Revenue grew a respectable 7% to $4.51 billion, though this was $10 million less than expected by analysts. Adjusted earnings-per-share of $2.08 compared favorably to $1.86 in the prior year, which was $0.06 ahead of estimates.
A lower share count of 1% in the most recent period was only partially responsible for the nearly 12% increase in earnings-per-share, but this was far from the whole reason. Cost of revenue did rise 7.5%, but Automatic Data Processing's net profit margin improved 60 basis points to 19.1%.
The company's Employee Services segment, which accounted for ~67% of revenue, was the primarily driver of growth during the quarter. Revenue grew 9%, but earnings improved 17%, resulting in a profit margin of 33.1% compared to 30.9% in the previous period.
Importantly, organic revenue growth for this segment was higher by 8% due to strength in new business bookings and a small improvement in pays per control. A 70-basis point increase in the average client funds yield to 2.6% provided additional revenue as well.
PEO Services revenue was up 3% as a gain in worksite employee growth was partially offset by fewer pays per control. As a result, this segment's margin fell 90 basis points to 15.2%.
Automatic Data Processing reaffirmed much of their guidance for fiscal year 2024, with revenue projected to be 6% to 7%. Adjusted earnings-per-share are expected to grow 10% to 12%. Both projections are near the long-term averages for the company, which demonstrates the consistency of the company.
Risks to Investment Thesis
As attractive as an investment that I believe Automatic Data Processing to be, there are some risks to consider.
First, Automatic Data Processing largely depends on the health of the economy. If clients were to reduce employee levels by a significant amount then this would have an impact on results.
The good news here is that there is evidence of the company weathering a difficult operating environment in its recent past. Automatic Data Processing performed quite well during the years covering the Great Recession, with adjusted earnings-per-share never declining year-over-year and total growth approaching almost 31% for the 2007 to 2010 period. Bottom-line results also moved higher during the worst of the Covid-19 pandemic.
Shares of the company are also trading with an elevated multiple, which generally comes from generating consistently high results over a lengthy period of time.
The stock trades at almost 26 times forward earnings estimates for the fiscal year. Investors have been willing to pay for the company's growth rates, but a slow down due to competition, from peers such as Paychex, Inc. ( PAYX ) and Paycom Software Inc. ( PAYC ), could cause the market to reevaluate the multiple at a lower level.
Dividend Analysis
Following a 9.6% increase for the January 1st, 2024 payment date, Automatic Data Processing has now raised its dividend for 49 consecutive years.
The company already qualifies as a Dividend Aristocrat, but it is now just one more year away from joining the exclusive Dividend King index. This would place Automatic Data Processing among rarified air as there are just 54 companies in the market place that have the minimum 50 years of dividend growth to qualify for this index.
As a result, Automatic Data Processing has one of the most consistent track records of dividend growth, especially in comparison to its peer group.
Furthermore, Automatic Data Processing's dividend history leads to very high marks for its dividend.
The only category under dividends where the company is not in the "A" range is on yield. However, the stock offers a solid yield of 2.4%, which, though not exceptionally high, does offer a superior level of income compared to the average yield of 1.5% for the S&P 500 Index. Additionally, this is slightly ahead of the stock's 10-year average yield of 2.3%.
The dividend looks to be very safe as well. The projected payout ratio for the current fiscal year is a reasonable 55%, which is below the long-term average payout ratio of 60% since fiscal year 2014.
Given the historical trends for earnings growth, the projected double-digit improvement for the current fiscal year, and the payout ratio, it appears that Automatic Data Processing is poised to continue to grow its dividend for years to come as the company makes its entrance into the Dividend Kings.
Final Thoughts
A dividend growth streak of nearly 50 years requires that a company continue to generate profits, which is something that Automatic Data Processing has been an exceptional job at over the years. The company's ability to increase profitability at a rate of almost twice its revenue growth has resulted in shareholders seeing a high dividend growth rate for a lengthy period.
While shares do not offer the highest of yields, the company's ability to continuously grow its dividend means that shareholders can likely expect to see close to double-digit increases for years to come. This makes Automatic Data Processing a highly reliable investment choice for dividend investors.
For further details see:
Automatic Data Processing: Profitability Track Record Supports Dividend Growth