ADP vs Paychex Scorecard

By Chad Henage - February 8, 2012 | Tickers: ADP, PAYX | 0 Comments

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When it comes to payroll processing there are the big two, and then there is everyone else. There are still hundreds of small payroll processors out there, but when companies search for a payroll processor they are likely to hear Automatic Data Processing (NASDAQ: ADP) or Paychex (NASDAQ: PAYX) first. Since most investors like to choose one company in an industry for their portfolio, let's compare these two giants and see which one comes out on top. The one with the highest score wins.

Earnings and Valuation 

This one is close. Both companies are well known and their growth is tied to employment. The market appears to be betting that as the economy recovers, both companies will do well. They are priced nearly the same in every respect. This one is a tie (ADP – 1, Paychex – 1)

Previous Earnings Growth

ADP and Paychex are expected to grow over 10% in the next 5 years, but can the last 5 years tell us anything? History might not predict future results, but it can be a good indicator. In this case ADP has grown earnings by 4.91% and Paychex has seen a decline of -0.68%. Even in the most difficult years the economy has been through in a while, that ADP was still able to grow. (ADP – 2, Paychex – 1)

Earnings Beats

If a company beats earnings estimates there are two things that usually happen. First, the stock can see a pop from the unexpected earnings. Second, the company might be seen as undervalued as estimates are used so frequently to guess the value of a stock. In the last 4 quarters ADP has met estimates 3 of the 4 and missed 1 time. Paychex on the other hand, has beaten estimates 3 of the last 4 quarters and met once. This one clearly goes to Paychex. (ADP – 1, Paychex – 2)

Average Cash Flow Per Dollar Of Assets

In theory, the company that generates the most free cash flow per dollar of assets is the more efficient operator. To compare companies I use average cash flow per dollar of assets. To get this number I use the following formula: (annual operating cash flow – annual capital expenditures) / 4 = average cash flow, then take average cash flow and divide into total assets) This shows how much free cash is generated per each dollar of total assets. I will say I was surprised by the result. ADP comes in at $0.0145 per $1 of assets, Paychex comes in at $0.03 per $1 of assets. This literally means that Paychex is twice as efficient generating cash per $1 of assets as ADP. (ADP – 1, Paychex – 2)

Dividend Yield & Cash Payout Ratio

Many studies have shown that sustainable dividend yields are critical to long term market outperformance. With this in mind ADP has a yield of 2.89% and Paychex pays 4.04%. Clearly this is an advantage for Paychex. However, this is only an advantage if the yield is sustainable. ADP's cash payout ratio after capital expenditures is about 43%. Paychex cash payout ratio after capital expenditures is about 76%. While a 76% payout for Paychex is higher than I would prefer to see, it should be sustainable. Since Paychex has the higher yield and it appears sustainable Paychex takes this category. (ADP – 1, Paychex – 2)

Balance Sheet Strength

Both companies have very strong balance sheets. ADP has a large net cash position as does Paychex. Since the companies both have a positive net cash position, the only way to compare is net cash versus market capitalization. In ADP's case, their cash and investments are about 76% of their market cap. Paychex has cash and investments of about 32% of their market cap. ADP is holding more cash per dollar of market cap. This could indicate the market isn't placing enough value on the cash that ADP is sitting on. (ADP – 2, Paychex – 1)

Conclusion

Looking at the two companies we have found that each has certain strengths over the other. When we add it all up ADP comes in with 8 points and Paychex has 9 points. We knew this was going to be a close race and it certainly was. Paychex is the winner by a slight margin according to our comparison. A case could be made, in the dividend area, that ADP's lower payout ratio gives the company more flexibility to continue raising their dividend versus Paychex. Use these numbers as a starting point for your own research, and see which one wins a spot in your portfolio.

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