Stock to Watch: Automatic Data Processing, Inc. (ADP)

Automatic Data Processing (ADP) provides technology-based outsourcing solutions to employers. It operates in three segments: Employer Services, Professional Employer Organization Services, and Dealer Services. One of the major risk to their bottom line comes from auto dealer services division. In fiscal year 2008, 16% of their revenue came from that division. Some of their main competitors are Paychex (PAYX) and Administaff (ASF). ADP and PAYX are part of the dividend achiever. ADP has been there for 33 years and PAYX has been there for 20 years.

Fundamental Analysis

The table below shows a comparative analysis between the three companies.

My analysis shows ADP is undervalued when dividend yield reach 2% or higher. My conservative fair value is $52. Morningstar and Valueline has fair value at $51.

ADP is closest among the three companies to the 52 weeks low and that attracted my attention. After some analysis, I see that at $35, the stock is yielding 3.76%. As one of the dividend achievers since 1976, their prestige dividend record sets them apart from ASF and PAYX. Since 1993, ADP increased their dividend by 16% compound annually. As a result, if you invested $10,000 in ADP at its 52 week high in 1993 ($12.77), you would be sitting on a 10% yield or a yearly income of $1,000. Using a conservative scenario, if you purchased the stock at 52 week high in 1993 ($12.77) and sell it at 52 week low in 2009 ($32.03), you would have gained 150% profit excluding dividend. Including dividend, your $10,000 would be $27,140 or 171% gain. That is not bad considering 2000 and 2008 crash in the market.

Unemployment is one of the reasons the stock is deeply discounted. I took a look at 1982 when unemployment reached 10.8%. Shortly after, ADP reached its high of $2.50. How could this be? How can a company which deals directly with the employment market be reaching its peak corresponding to the peak in unemployment? The answer is, the stock discounted all the bad news. Please see the chart below.

Our employment is at 9.5% and I expect that figure to go higher. The stock at this price should have discounted most of the bad news. The dividend yield has never been this high. The same goes for payout ratio which sits at 56%. Based on the lowest analyst estimate, their earning should not fluctuate much so I am fairly confident that the dividend is safe. Another highlight is ADP strong balance sheet. Debt due in five years is $16.9 million. They hold $1.4 billion in cash. They reduced their debt level by 70% since 1999 (from $145.8 million to $45 million). Fundamentally, I believe ADP should be able to weather this downturn relatively better than their competitors and should come out of this with higher market share.

Technical

Immediate term (1 year), there are mixed signal in the chart. Bearish sign is from the chart trading below its 200 day MA. It's been unsuccessful at breaking and remaining above that trend line. The higher-low indicated by the blue line is a bullish pattern.

Longer term chart (5 years), shows a trading range from $34 and $42. Technical analysis shows a downside risk of $28.

Summary

I see ADP as a bargain below $41. Keynes once said "The market can stay irrational longer than you can stay solvent" and thus I must be very particular about my purchase. As a result, I wait until the stock is 10% within the yearly low.

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