TipRanks Smart Dividend Newsletter – Edition #16
Hello and welcome to the 16th edition of TipRanks’ Smart Dividend – a weekly Newsletter providing you with investment ideas for safe-bet quality stocks that are outstanding dividend payers, compared to their peers.
Today’s dividend stock recommendation is for the world’s largest payroll processing company, whose reputation is so well-regarded that its reports are used by policymakers as one of the central data points in their policy decisions. The company we are recommending has been raising its dividends for 48 years, while its solid execution and strong profitability support the expected continuation of increasing shareholder compensation.
But first, let us present a brief investment thesis, supporting our recommendation.
Investment Thesis: Automating Humanity
With the advancement of our civilization into the digital age, the importance of human capital has increased immensely. Companies that facilitate the convergence of technological innovation and essential Human Capital Management (HCM) services take central stage. The efficient management of human resources is pivotal in today’s business landscape, and the HCM services sector stands as an indispensable pillar. Efficient HCM not only ensures smooth payroll operations but also optimizes workforce potential, driving organizational success.
Furthermore, cloud computing and artificial intelligence (AI) have unlocked new dimensions within this industry. These advancements have not only streamlined payroll processes but have also ushered in an era of data-driven insights, catalyzing better decision-making for businesses worldwide.
The intersection of HCM and technology presents a remarkable investment opportunity. The allure of investment in such an industry lies in its inherent stability. Companies in this industry provide indispensable services; those of them who can boast wide moats, fortified by a sticky customer base, look like a haven of stability among their smaller, more volatile peers.
Economies of scale are especially important as they reduce per-unit costs, enhancing profitability. The industry’s giants have demonstrated their commitment to shareholders through consistent dividend increases, presenting a compelling case for investors seeking steady growth and income.
Quality Dividend Stock: This Week’s Top Pick
Automatic Data Processing, Inc. (ADP) is one of the leading providers of cloud-based human capital management (HCM) solutions worldwide, and the world’s largest payroll processing firm.
ADP operates in two segments: Employer Services and Professional Employer Organization (PEO). The Employer Services segment offers strategic, cloud-based platforms, and human resources (HR) outsourcing solutions. This segment provides payroll, talent management, benefits administration, workforce management, HR management, insurance, retirement, and compliance services. The PEO Services segment provides HR outsourcing solutions to small and mid-sized businesses through a co-employment model. This segment, responsible for about 35% of ADP’s revenue, offers benefits packages, protection and compliance, talent engagement, expertise, comprehensive outsourcing, and recruitment process outsourcing services.
The company was founded in 1949 under the name of Automatic Payrolls, Inc. as a manual payroll processing business. In 1961, the company changed its name to Automatic Data Processing, Inc., and began using punch card machines, check printing machines, and mainframe computers. ADP’s first venture abroad was in 1965 when it established a subsidiary in the U.K.; since then, the company has established multiple locations around the globe. Its headquarters are located in Roseland, New Jersey.
The company began its expansion into adjacent fields and industries, with an emphasis on keeping up with the computerization trend, with two acquisitions of computer services companies in the 70s. Since then, ADP has acquired 33 companies worldwide, with the latest buyout being that of workflow automation and data integration software company Sora in August 2023.
In addition to the expansion through strategic acquisitions, the company invests heavily in innovation and continuous product and service development. In fiscal year 2023 ADP has invested $1.2 billion in systems development & programming. The company views technological change as a business opportunity, where it can employ its knowledge to capitalize on every new development. Thus, it was among the first in its sphere to offer cloud services; now it incorporates Generative AI into its product suite.
ADP went public in 1961 with 300 clients and 125 employees. Today, ADP serves more than 1 million corporate clients in 140 countries. The company commands a market capitalization of $102.7 billion, a workforce of 60,000, and an annual revenue of $18 billion.
ADP is one of the largest global providers of HCM services in North America, Europe, Latin America, and the Pacific Rim. It caters to clients with workforces ranging from a single employee to tens of thousands of staff members across the world. More than 80% of the Fortune 500 companies are among ADP’s clients; Automatic Data Processing, Inc. itself is a Fortune 500 list member.
ADP’s total addressable market size is estimated at around $150 billion, with an expected annual growth of 5%-6%. The company’s client base is diversified across geographies, industries, and company sizes. Out of 41 million workers across the globe whose payrolls are processed through ADP, about 60% are in the U.S. The company caters to businesses of all sizes, from mom-and-pop shops to multinational conglomerates. It provides locally adjusted software and services in multiple languages.
ADP’s advantages over its competitors include its vast economic moat and unmatchable scale, as well as high-quality customer service, which helps with very high customer retention levels. Besides, HCM services, and specifically payroll handling, are a “sticky” business, since changing providers is a costly and complicated process, especially for large firms.
As the nation’s largest payroll processor, handling payroll for about a fifth of the U.S. private workforce, it can easily survey job market trends. For many years, the company has been publishing the ADP® National Employment Report, which has become one of the most-watched economic indicators, providing valuable labor-market insight to businesses, governments, and the public.
Although the company is historically listed within the Industrial sector, in the last decades it has been a provider of software and online services; thus, it is best compared to similar companies in the IT Sector (Industry: Information Services).
Long-time dividend investors are probably familiar with Automatic Data Processing since the company is a Dividend Aristocrat. By definition, Dividend Aristocrats are companies within the S&P 500 (SPX) with 25+ years of consecutive dividend growth. ADP has 48 years of consecutive dividend increases under its belt. Its current dividend yield of 2.0% is higher than the IT sector’s average of 1.03%. The company’s payout ratio is a comfortable 58% and is well-supported by cash flows. Dividend-per-share increased at a CAGR of 11% in the past decade and is expected to be raised at about an 8% to 10% annual rate in the future. The latest dividend increase was announced in November 2022, when the company raised its payout by 20%.
In addition to dividends, ADP views share repurchases as an important part of its policy of returning value to its shareholders. The company has a long-standing buyback program in place, which targets at least a 1% share count reduction per year. The latest program renewal, where the company approved an additional $5 billion allocation with no expiration date, was in November 2022. In fiscal Q4 2023 (ending June 30), the company repurchased shares for the amount of $1.1 million.
Automatic Data Processing, Inc. is expected to continue increasing its dividends and total shareholder compensation in the years to come since its strong financial position supports this outlook. ADP’s net debt-to-equity ratio is a low 28%, with the debt well-covered by operating cash flow, while EBIT covers interest repayments many times over. The company’s costs of serving its debt are low thanks to its high credit rating. ADP’s debt is rated “AA-“ at Fitch and S&P Global Ratings, the strongest in the HCM industry, and a rating that reflects its very low risk.
Furthermore, most of ADP’s profitability and capital efficiency metrics are outstanding. While its Return on Assets (ROA) of 7% is in line with the average for its industry, its Return on Equity (ROE) of 97% is no less than exceptional. The company’s operating margin of 25%, net profit margin of 19%, and FCF margin of 22% are much higher than average for its sector. In addition, the company’s continued strength in free cash flow generation supports its dividend and stock buyback policies.
In Q4 of fiscal year 2023 (ending June 30), the company surpassed analysts’ revenue and earnings expectations, delivering a strong EPS beat, as it did in all quarters for which estimates were published. In FY 2023, ADP’s revenues rose 10%, while net earnings grew by 16% and EPS increased by 17% versus FY 2022. In the past five years, which include the Covid-19 impact, ADP has been growing revenues at an average annual rate of 6.3%, while its EPS increased at a clip of 14.1% in the same period. Thanks to the company’s many competitive advantages, such as a sticky customer base, it can perform relatively well through good times and bad, remaining highly profitable even in times of recession.
All these advantages did not go unnoticed by the investors. Although the company’s stock, traded on NASDAQ, is up only 2.2% in the past 12 months, that includes a strong sell-off at the beginning of the year from ADP’s all-time high in December 2022. Since the stock bottomed out in May, it has regained its posture on optimistic reports coming out from the company and rebounded by 20%. This rally has brought the company’s valuation up a few notches, and it’s currently trading at a TTM P/E of 30.4 and Forward P/E of 27.4, representing a premium of 20% and 5%, respectively, over the IT sector’s averages. However, when comparing ADP’s valuation to its competitors, the company doesn’t look as expensive, as ADP peers’ average TTM P/E stands at an eye-popping 63.
Apparently, institutional investors view the stock price as a bargain, since Automatic Data Processing’s stock has seen an increased hedge fund interest in recent months, with a number of funds opening large new positions of increasing their holdings by hundreds of percent.
ADP has a TipRanks’ Smart Score rating of “Perfect 10”:
In conclusion, we believe that ADP’s wide economic moat, coupled with its ability to churn out steady profits even in difficult times, and its strategy of raising dividends and increasing total shareholder compensation, make it a compelling income investment stock and a valuable addition to any long-term investment portfolio.
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