In an era where technology and human resource management intersect, Automatic Data Processing, Inc. (ADP) stands out as a key player. Known for its comprehensive payroll services and human capital management solutions, ADP’s extensive experience, expertise, insights, and cutting-edge technology have transformed human capital management from an administrative task into a strategic business advantage. This positions ADP with a promising growth runway. The question is whether now is the right time to invest?
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of ADP. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I don't own any stocks in ADP's competitors either. Thus, I have no personal stake in ADP. If you want to purchase shares or fractional shares of ADP, you can do so through eToro. eToro is a highly user-friendly platform that allows you to start your investment journey with as little as $50.
The Business
Automatic Data Processing, Inc. (ADP) was founded in 1949 in New Jersey, United States, with the idea of helping clients focus on their core business by managing their payroll challenges. Today, ADP is one of the world’s leading technology companies, offering comprehensive cloud-based human capital management (HCM) solutions that integrate HR, payroll, talent, time, tax, and benefits administration. ADP serves over 1 million clients and pays more than 41 million workers across 140 countries and territories. ADP’s operations are divided into two reportable segments: Employer Services and Professional Employer Organization (PEO). Employer Services caters to clients of all sizes, from small businesses with a single employee to large enterprises with tens of thousands of employees globally. ADP offers a wide range of solutions, including Payroll Services, Benefits Administration, Talent Management, HR Management, Workforce Management, Compliance Services, Insurance Services, and Retirement Services. The PEO segment provides comprehensive employment administration outsourcing solutions through a co-employment arrangement, where ADP shares employer responsibilities, like payroll processing and tax filings, with the client. This arrangement is particularly beneficial for small and mid-sized businesses without in-house HR expertise. Employer Services contribute 68% of ADP’s revenue, while Professional Employer Organization adds 32%. ADP generates most of its revenue from subscription fees, resulting in long-term client relationships and consistent recurring revenue. ADP is highly regarded in the HR and payroll services industry, boasting a strong brand moat. This moat is strengthened by ADP’s unique ability to reach clients effectively and retain them over the long term, underscoring the reliability and essential nature of its services. Additionally, high client satisfaction reflects ADP’s commitment to supporting businesses with a wide array of solutions.
Management
Maria Black is ADP’s CEO, appointed in January 2023, after joining the company in 1996 as a sales associate and rising through various roles over two decades. She holds a Bachelor of Arts degree in Political Science and International Affairs from the University of Colorado, Boulder. Maria Black was chosen as CEO due to her proven leadership skills and deep understanding of ADP’s operations, having worked across numerous positions within the company. Her experience gives her a unique, well-rounded perspective on ADP’s products, innovation strategies, and growth opportunities. As CEO, she introduced three strategic priorities: advancing best-in-class HCM technology, providing unmatched expertise and outsourcing solutions to clients, and leveraging ADP’s global scale. These goals are aimed at strengthening ADP’s competitive advantage. Maria Black’s leadership is also well-regarded by employees, with an impressive employee satisfaction score of 89/100 on Comparably, placing her in the top 5% for companies of similar size. Although it’s still early in her tenure to assess her long-term impact as CEO, her experience and strategic focus position her well to lead ADP forward.
The Numbers
The first metric we will investigate is the return on invested capital (ROIC). I would like a 10-year history demonstrating a minimum growth of 10% each year. ADP's return on invested capital (ROIC) has consistently exceeded expectations, achieving over 20% for the past ten years and surpassing 30% for the last six. Notably, ADP delivered its highest ROIC in the past three years, with impressive results above 45%. Although ROIC decreased slightly in fiscal year 2024, it still remained over 49%, which is hardly a concern. These figures underscore ADP’s quality and long-term compounding potential for investors.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most significant of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are used to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. The numbers are a bit mixed, which can partly be explained by acquisitions. For example, ADP has acquired companies such as The Marcus Buckingham Company, Global Cash Card, WorkMarket, Celergo, and Sora over the past 10 years, which has affected its equity. Therefore, I’m not concerned about ADP’s occasional lack of annual equity growth. Encouragingly, ADP has managed to grow its equity over the past two years, a positive sign for its financial stability and long-term prospects.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. ADP has consistently generated positive free cash flow over the past decade, increasing it year over year in seven of the last ten years. While free cash flow saw a slight decline in fiscal year 2024, it still reached its second-highest level ever, which is encouraging. The levered free cash flow margin also dipped slightly but remains at its second-highest level to date. The current free cash flow margin is below the ten-year average, suggesting a high valuation for the shares—a point we'll revisit later in the analysis.
Debt
Another important aspect to consider is the level of debt. It’s essential to assess whether a business has manageable debt that can be repaid within a three-year period, which we calculate by dividing the total long-term debt by earnings. After reviewing ADP's financials, I found the company has only 0,12 years of earnings in debt. Therefore, ADP has minimal debt, making it a non-issue from an investment perspective.
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Risks
Based on my findings so far, I find ADP to be an intriguing company. However, no investment is without risk, and ADP has its fair share of risks. One primary risk is competition, which poses challenges to ADP’s market share, pricing power, and need for continuous innovation. ADP operates in a highly competitive landscape with numerous companies offering similar Human Capital Management (HCM) and outsourcing services. Major competitors include business outsourcing companies, ERP service providers, and cloud-based HCM providers. Large players like Paychex, Workday, Intuit, Oracle, and SAP hold strong positions, putting pressure on ADP to differentiate itself continuously. In the mid- and down-market segments, competitors increasingly compete on price, which could create downward pressure on ADP's pricing. While ADP hasn’t observed significant price compression recently, the prevalence of promotions and discounts in the industry could gradually erode its pricing power. Furthermore, ADP faces competition from companies opting to develop and maintain in-house HCM systems. For businesses with unique customization needs or strict data sensitivities, internal solutions can be appealing, potentially limiting ADP's reach.
Industry regulations present a substantial risk for ADP due to the complex, extensive, and ever-evolving legal landscape that governs its operations and services. As a provider of payroll, human capital management (HCM), and benefits administration services, ADP must comply with a broad range of U.S. and international laws, including privacy and data protection regulations like GDPR and CPRA, as well as anti-money laundering (AML) and anti-corruption standards. Each of these regulations affects distinct areas of ADP’s business, creating ongoing compliance challenges. Failing to meet these requirements could result in substantial fines, licensing complications, service restrictions, or lawsuits, all of which could harm ADP’s reputation and financial health. Additionally, changes in payroll tax or fund transfer regulations could affect ADP’s revenue by reducing remittance timeframes, which would lower interest income. This intricate regulatory environment requires continual investment in compliance efforts, and any lapse could lead to financial penalties, reputational damage, and operational disruptions that might weaken ADP’s competitive position.
Cybersecurity risks are a serious concern for ADP, given the scale and nature of its operations, which involve handling vast amounts of sensitive personal and financial data—such as payroll, healthcare, tax, and bank account information—as well as managing client funds. Any security breach could lead to significant repercussions for ADP, including operational disruptions, increased expenses, reputational harm, and legal liabilities. These risks are heightened by the sophistication of modern cyber threats, with attackers targeting high-value data and financial transactions that ADP processes. Although ADP has established comprehensive security programs to prevent and address cyber incidents, the complexity of its operational environment and the evolving nature of cyber threats make it challenging to completely eliminate vulnerabilities. A breach could result in data loss, unauthorized access, or misappropriation of funds, leading to client distrust, regulatory penalties, and legal actions. While ADP does carry cyber insurance, coverage may be insufficient in the event of a large-scale cybersecurity incident, particularly as cyber threats continue to advance. A serious or even perceived security failure could erode client confidence, prompting them to seek alternative providers, which would pose a material risk to ADP’s revenue, client retention, and market position.
Reasons to invest
There are also numerous reasons to invest in ADP. ADP operates in the highly attractive Human Capital Management (HCM) industry, presenting robust growth potential due to the essential nature of its services. HCM solutions are fundamental for businesses of all sizes, as companies rely on efficient payroll, HR, benefits, and workforce management systems to operate smoothly. This "all-weather" demand for ADP's services makes them indispensable, ensuring consistent revenue streams even during economic downturns. The company’s total addressable market is valued at around $150 billion, covering payroll, workforce management, HR, benefits, talent, HR outsourcing, analytics, and payments. With ADP’s current revenue at approximately $19 billion, this leaves substantial room for growth as more businesses turn to third-party HCM solutions for improved efficiency and compliance. This favorable market landscape supports ADP’s long-term potential, as demand for efficient HR tools and payroll solutions is driven by regulatory complexity and the evolving needs of both employers and employees.
ADP’s strategic focus on artificial intelligence (AI) presents a compelling investment case, as AI enhances efficiency, client experience, and revenue potential. Through solutions like ADP Assist, a generative AI-powered tool, ADP integrates AI-driven insights across its Human Capital Management (HCM) platforms to streamline HR, payroll, and compliance functions. This approach has yielded significant efficiency improvements, enabling faster report generation and simplifying HR tasks, allowing clients to access insights more seamlessly. ADP’s AI initiatives also optimize internal operations by automating tasks such as call summarization and data entry, reducing implementation errors and improving client onboarding. These advancements contribute to high client retention rates by enhancing user experience and delivering data-driven support, reinforcing long-term client relationships and recurring revenue. As AI applications evolve, ADP is well-positioned to explore new monetization opportunities within its vast client base. By continually developing AI-based features, ADP not only enhances product efficiency but also increases customer satisfaction, bolstering its competitive edge and growth trajectory in the rapidly advancing HCM market.
ADP’s international growth offers a strong investment case as the company expands into global markets and diversifies its revenue streams. With just 15% of its revenue currently generated outside the U.S., ADP sees considerable opportunity to grow its Human Capital Management (HCM) offerings globally. Under CEO Maria Black’s leadership, international expansion has become a priority. ADP’s established infrastructure across over 140 countries enables it to serve multinational clients and address the unique needs of distributed, global workforces. This extensive reach is a key differentiator, especially for businesses seeking an HCM provider with seamless global capabilities. ADP’s ability to handle complex payroll and compliance across varied regions strengthens its competitive position and supports the rising demand for cross-border HCM solutions. By strategically entering high-growth markets and integrating local expertise, ADP is well-positioned to meet the evolving needs of global clients, ensuring it can capture new growth opportunities worldwide.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 9,10, which is from the fiscal year 2024. I have selected a projected future EPS growth rate of 12%. Management expects EPS to grow between 11-13%. Additionally, I have selected a projected future P/E ratio of 24, which is twice the growth rate. This decision is based on ADP's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $167,67 We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy ADP at a price of $83,84 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 4.158, and capital expenditures were 563. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 394 in our calculations. The tax provision was 1.120. We have 408,1 outstanding shares. Hence, the calculation will be as follows: (4.158 – 394 + 1.120) / 408,1 x 10 = $119,68 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With ADP's free cash flow per share at $9,65 and a growth rate of 12%, if you want to recoup your investment in 8 years, the Payback Time price is $132,94.
Conclusion
ADP is an intriguing company. While it has new management, CEO Maria Black has been with ADP for over two decades, giving me confidence in her leadership. ADP has consistently delivered a high ROIC and recorded its highest free cash flow in the past two years. However, competition poses a risk, as ADP operates in a crowded HCM market with established players that challenge its market share, pricing power, and innovation capabilities. Additional pressure from in-house solutions and price-based competition in mid and down-market segments could also erode ADP’s reach. Industry regulations present another risk, requiring ADP to navigate an intricate and evolving legal landscape across privacy, anti-money laundering, and tax laws. Cybersecurity is also a significant concern due to the sensitive data ADP processes, making it a prime target for cyberattacks. A security breach could lead to financial, legal, and reputational consequences, potentially causing clients to lose confidence in ADP’s services. On the positive side, ADP operates in the essential Human Capital Management (HCM) industry, where demand for payroll, HR, and workforce management solutions remains steady regardless of economic conditions. ADP has substantial room for growth, with a total addressable market estimated at $150 billion as businesses increasingly turn to third-party HCM solutions for efficiency and compliance. ADP’s focus on AI further enhances operational efficiency, client experience, and long-term growth potential, strengthening client retention and positioning ADP to capture new revenue streams. Additionally, ADP’s international growth potential is compelling, as it expands its Human Capital Management services to diversify revenue streams and tap into new markets. With a presence in over 140 countries, ADP can support multinational clients with complex payroll and compliance needs, solidifying its position as global demand for cross-border HCM solutions rises. Overall, there are many positives to ADP, and purchasing shares below the intrinsic value of the Ten Cap price of $239 could present a great long-term investment opportunity.
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