Beating Buffett

Automatic Data Processing, Inc. [ADP: $40.30] expects nearly $9 billion in revenues from approximately 570,000 clients. They are one of the world’s largest providers of business outsourcing solutions. ADP offers the widest range of HR, payroll, tax and benefits administration solutions from a single source. ADP is also a leading provider of integrated computing solutions to auto, truck, motorcycle, marine and recreational vehicle dealers throughout the world.

After decades of consistent growth ADP’s earnings have likely plateaued in the FY ending June 30^th. As the largest provider of payroll and tax filing services to large businesses ADP has been hit with reduced demand tied to the absolute loss of jobs since the recession began in 2008. Despite that substantial headwind, ADP posted all-time record earnings of $2.39 /share in FY 2009. Zacks sees FY 2010 (ends June 30, 2010) coming in at the same $2.39 level with the year ahead forecast at $2.53.

Finances are solid with over $2 billion in treasury cash against total debt of only $41 million. Value Line gives ADP their highest rankings for both safety and financial strength. They also note that ADP falls into the top 1% (of all 1700 equities they cover) in terms of ‘stock price stability’ and ‘earnings predictability’.

Capital needs are minimal and dividends have been raised every year to sit today at $0.34 quarterly for a current yield of 3.37% - better than the interest on a 5-year U.S. Treasury note.  

ADP is now offered for about 16.8x trailing and 15.9x year-ahead earnings versus its 10-year median multiple of 25x. 2009 and YTD 2010 have been the only years of the past sixteen that the P/E has averaged below 20x.

While it’s unlikely that ADP will command a historically high multiple soon I don’t think it’s farfetched to expect a bounce back to at least 18x forward earnings. That would take these shares back to $45.54 or about 13% above this afternoon’s quote. Standard and Poors reached a similar conclusion with a 12-month target price of $47 /share.

Add in the yield and you’ve got a top-quality, low-risk issue that could produce better than a 15% twelve-month total return. Not too bad in our present, near-zero interest rate world.

Want something more exciting with even lower risk? Consider this:

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Automatic Data Processing (ADP) and Paychex (PAYX) are the dominant players in the payroll-accounting/tax filing processing space with Automatic Data serving mainly huge companies and Paychex targeting small to mid-size firms.

Each company is virtually debt free and both of them pay generous dividends by today’s standards. Value Line rates both companies at the 95^th percentile for ‘earnings predictability’ due to the recurring nature of their services. ADP and PAYX get outstanding marks for safety and ‘stock price stability’ as well. Each of them has a well below average Beta.

They are the epitome of high-quality, conservative, low-volatility shares. Both ADP and PAYX will likely have posted slightly lower EPS in their latest FY as revenues are tied to the nation’s total employed population.

Paychex earned $1.48 /share in the FY ended May 31 down from a record $1.56 /share in FY 2008. Automatic Data Processing actually set new record earnings of $2.35 in FY 2009 (ended June 30^th) versus their prior FY’s previous all-time high of $2.20 /share. These were very good performances considering the present economic climate.

Zacks now sees FY 2010 – 2011 earnings of $1.34 and $1.46 for PAYX and $2.35 and $2.51 for the current FY and into FY 2011 for ADP.

Here are the per-share* figures for ADP as reported by Value Line:

* ADP spun off its brokerage services in March 2007. Those operations accounted for $1.93 billion in FY 2006.

ADP now trades for $37.60 /share or 16x current year estimates. The well- covered dividend provides a 3.51% current yield. The P/E equals the lowest and the yield the highest in over twenty years (excluding the recent panic lows). In fact, ADP rarely has traded for < 20x earnings in its entire history.

A rebound to even 18x forward earnings of $2.35 would bring ADP back to $42.30 /share. Morningstar assigns a 4-Star rating (out of 5) to ADP shares and sees “fair value” as $51.

Automatic Data has actually traded at $41 and higher in each year since 1998. EPS back then were only $0.99 or less than half today’s level. The dividend in 1998 was $0.26 compared with $1.32 now.

Here’s a very conservative play with ADP that can still generate outstanding total return with very low risk. Read more…

One issue that meets my criteria right now is:

Automatic Data Processing [NYSE:ADP] Feb. 18, 2009 close: $36.84
52-week-range: $30.83 (Oct. 16, 2008) - $45.97 (Sep. 9, 2008)
Dividend = $0.33 quarterly = 3.58% current yield

ADP is America’s largest payroll and employee tax filing processor with over 585,000 accounts. Domestic revenues account for about 82% of their approximately $9 billion in expected sales for FY 2009 (ends June 30, 2009). They also provide Human Resource solutions and various accounting, inventory and leasing services to smaller companies.

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