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Is ADP A Buy?

One of the places that investors can look to for dividends are the payroll processing companies. This industry is dominated by the two largest processing companies which are ADP (ADP) and Paychex (PAYX). Both companies compete to be the main administrator of payroll and benefits management for small and medium sized business. Let’s take a look at the leading payroll company and see if its shares are a buy.

Automated Data Processing is currently trading at $45 per share. The stock trades at 17 times earnings which is pretty expensive considering that the company is growing at a 10% rate. The company’s growth has been hindered by the bad economy like many of its competitors. Earnings peak in the payroll processing industry when the economy is performing well and unemployment is low. That has not been the environment for ADP over the past few years.

Last quarter ADP beat the market’s expectation by achieving top line revenue growth of 14%. The company is now forecasting earnings growth for the year of 7%. This number made not seem that large but it is. It is amazing that ADP has been able to achieve the growth that it has in the current economic environment. Paychex for example reported a bad earnings number last quarter and is struggling to keep up with the competition.

ADP has a great balance sheet with $1.4 billion dollars in cash and just $34 million dollars in debt. ADP is currently paying investors a dividend of $1.44 per share and has a 3% yield. The 3% yield is close to being in line with the historical dividend yield of 2.9%.

This is below the 4.6% yield that Paychex is offering. ADP’s dividend is much more sustainable considering that the payout is slightly more than 50% of the company’s earnings. That is much easier to maintain than the near 100% dividend payout that Paychex is offering. If earnings stay at the same rate going forward Paychex will be looking at a dividend cut while ADP’s dividend has room for an increase.

Investors should not run out and buy shares of ADP now as the stock is likely to get much cheaper over the next few weeks. Although the dividend is solid, shares are not yet a bargain. With the stock trading at 2.2 times book value and nearly 2 times earnings, ADP is still too pricey in a market with much cheaper stocks.

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