Automatic Data Processing Inc (ADP)

Conclusion

Automatic Data Processing provides cloud-based human capital management software and HR outsourcing through its Employer Services and Professional Employer Organization segments. At a price of 302.06 USD, the market capitalisation is 119.2 billion USD.

The verdict is fair. The fair value band runs from 238.19 to 357.29 USD with a midpoint of 297.74 USD, giving a margin of safety of -1.4% at the current price. Against their own ten-year medians, the price-to-earnings ratio is 26.3 against 30.2, a premium of -12.8%, and the price-to-free-cash-flow ratio is 23.9 against 29.4, a premium of -18.6%. The DCF gives 261.56 USD per share at a discount rate of 8.87%. The reverse DCF implies growth of 8.44% a year, against revenue growth of 7.9% and free cash flow per share growth of 16.8% over five years.

What holds the case up is ROIC of 63.7% against a WACC of 8.78%, free cash flow conversion of 110.1% on a trailing basis, and eight earnings beats in eight quarters. What would weaken it is the liquidity cushion: a current ratio of 1.03 and a quick ratio of 0.13. The Altman Z-score of 2.52 sits in the grey zone, and the price-to-book ratio of 23.4 is 33.5% above its ten-year median.

Financial health

Financial strength is green, held up by net debt to EBITDA of 0.33 and interest coverage of 12.8x, while the current ratio of 1.03 and quick ratio of 0.13 are only neutral. Debt to equity is 1.07. The Altman Z-score of 2.52 is in the grey zone, but that model was designed for manufacturers, which this software company is not. Insolvency risk is medium, with a probability of 10.1% by the estimate of the Ohlson model. The company's liquidity is thin on the quick measure, so a fall in receivables collection or a delay in client funds would matter more than the leverage figures suggest.

Earnings quality

Earnings quality is green, with free cash flow conversion doing most of the work: 110.1% on a trailing basis and 106.4% over five years. The accrual ratio is -1.76%, meaning reported earnings are backed by cash rather than by accounting entries. Stock-based compensation is 1.13% of revenue, and free cash flow after it is 4.73 billion USD. The share count fell at a compound rate of 1.38% over five years, which points to buybacks. The Piotroski score is 4 out of 9, which is neutral. The Beneish M-score is not available. The company beat estimates in all eight of the last quarters, with an average surprise of 2.0%. Current-year estimates were revised up 16 times in the last 30 days and down none, and next-year earnings growth is estimated at 9.41%.

Profitability

Profitability is green. The gross margin of 50.1% is above its ten-year median of 46.8%, the operating margin of 24.8% is above 21.8%, and the net margin of 20.3% is above 17.6%. Margin stability is 11.7%. ROIC of 63.7% sits against a WACC of 8.78%, and the given ROIC minus WACC value is 54.9 percentage points. Return on equity of 88.9% looks high because of leverage. The DuPont split explains it: a net margin of 20.1%, an asset turnover of 0.35 and an equity multiplier of 10.48. The returns come mainly from margins and capital efficiency, not from borrowing alone. The dividend yield is 2.24%, and the payout on free cash flow is 53.7%.

Growth

Growth is green. Revenue compounded at 6.8% over three years, 7.9% over five years and 6.5% over ten years. Earnings per share compounded faster, at 10.4%, 12.7% and 13.0% over the same periods, and free cash flow per share at 14.5%, 16.8% and 15.1%. Revenue grew in all 10 of the last 10 years. Revenue growth is steady rather than fast, and the gains in per-share figures have come partly from buybacks. The next-year earnings growth estimate of 9.41% is in line with the company's recent record, not above it.

Valuation

Valuation is yellow, because the margin of safety of -1.4% is close to zero. Today's price-to-earnings ratio is 26.3 against a ten-year median of 30.2, a premium of -12.8%. The enterprise value to EBITDA ratio is 18.4 against 20.3, a premium of -9.4%. The price-to-sales ratio is 5.36 against 5.37, a premium of -0.2%. The price-to-book ratio is 23.4 against 17.5, a premium of 33.5%. The DCF gives 261.56 USD per share at a discount rate of 8.87%, with the terminal value making up 57.8% of it, so the result depends heavily on long-term assumptions. The fair value from historical multiples is 333.92 USD. The reverse DCF implies growth of 8.44%, against revenue growth of 7.9% over five years and free cash flow per share growth of 16.8%. These figures are order-of-magnitude estimates built on fixed assumptions, including a 5% equity risk premium and capped growth. They are not a price target.

Risks

The main risk is the thin liquidity buffer, with a current ratio of 1.03 and a quick ratio of 0.13. A shortfall in cash would strain payments before any leverage problem appeared. The Altman Z-score of 2.52 in the grey zone and the medium insolvency probability of 10.1% add to this, though the Altman model does not fit a software business well. The valuation depends on the terminal value, which makes up 57.8% of the DCF, so a lower long-term growth assumption would reduce the value. The Beneish M-score is not available, so the risk of earnings manipulation cannot be checked with that test. This analysis has no debt maturity schedule and no revenue by segment, so it cannot show when debt falls due or which part of the business drives growth.