Are These Payroll Processing Companies Fairly Valued?

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The two major payroll processing companies in the United States, Automatic Data Processing (NASDAQ: ADP) and Paychex (NASDAQ: PAYX) are favorites of many income investors.  Both companies provide a critical service that nearly all companies need, and they pay their investors solid dividends.  Small competitor Insperity (NYSE: NSP) competes in the payroll processing industry as well.  After big rallies in these stocks over the last couple years, the issue at hand is whether there is further room for these shares to run.

Good Performance in a Challenging 2012

Automatic Data Processing is a $29 billion company that offers a wide range of human resources, payroll, tax, and benefits administration solutions to more than 600,000 business clients.  The company navigated 2012 well despite the continued challenges in the economy and sluggish recovery in employment.  Fiscal 2012 revenues grew 8% to $10.7 billion for the year, with acquisitions contributing about two percentage points of growth.  Diluted earnings per share increased 12% to $2.82. 

Paychex offers similar services, but is a smaller competitor with a market value of $12 billion. Paychex reported a 7% rise in revenues during fiscal year 2012, and earnings per share increased 6.3% year over year.  Paychex shares were not especially volatile in 2012, trading in a range of $30-$35 per share during the year.

Insperity’s shares have been on a wild ride over the last couple years, moving between $20 and $32 per share.  The company holds a market capitalization of less than $1 billion. Insperity performed well during the first nine months of 2012, with revenues climbing almost 10% year over year.  Diluted earnings per share soared 62%.  Unfortunately, its dividend remains barely above 2%.  

ADP’s financial position is strong, thanks to a very healthy balance sheet.  ADP remains one of only four non- financial U.S. companies rated AAA by both leading credit rating agencies.  In addition, the company is clearly committed to rewarding shareholders.  In 2012, ADP increased its dividend 10%, raising its distribution for the 37th year in a row.  ADP also bought back nearly $750 million in stock last year.  Because of the run up in its stock, the yield is now less than 3% at current prices.

Paychex offers a higher dividend than ADP, with a yield of over 4%, but not much room for dividend growth.  The company paid out 84% of its diluted earnings per share to investors in 2012.  Furthermore, the company has raised its dividend only twice since 2009.  The five-year compound growth rate of Paychex’s dividend stands at 1.9% per year.

Are Their Valuations Too Rich?

The performance of ADP’s shares has reflected its solid performance, rising more than 40% over the last three years.  Because of this, the stock now trades for more than 21 times its fiscal 2012 earnings.  ADP is trading at its highest price-to-earnings ratio over the last five years.  Likewise, Paychex is trading above its five-year average P/E ratio.  In addition, Paychex trades at a forward P/E ratio of 19 and a price-to-book ratio of 7.  Although both ADP and Paychex are successful businesses and are popular with income-oriented investors, it appears wise for investors to wait for a pullback before buying.

 


Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Automatic Data Processing and Paychex. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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