289% Profit From a “Boring” Dividend Stock?
A Top Dividend Stock for Income Investors
Payroll processing may not seem like an exciting business, but it is capable of returning a tremendous amount of value to investors. I’m talking about Automatic Data Processing (NASDAQ:ADP), a human capital management company headquartered in Roseland, New Jersey.
ADP started its business back in 1949 and has grown to become one of the biggest players in the industry. It serves approximately 700,000 clients located in more than 110 countries. The company provides a wide range of services, including human resources, payroll, talent, time, tax, and benefits administration. It has partnered with more than 7,000 different tax agencies across all levels of government in the United States.
To give you an idea of how dominant ADP is, here are some numbers. The company is responsible for delivering payroll for 26 million people in the U.S.—that’s one in every six workers in the country—plus another 14 million workers internationally. Around 80% of Fortune 100 companies use at least one of ADP’s services. (Source: “ADP: Driving Superior Results Through Market Leadership and Continuous Innovation,” Automatic Data Processing, last accessed April 19, 2018.)
The neat part about ADP’s business is that it is recurring. And because companies don’t usually trust startups to handle their important payroll information, it’s difficult for new competitors to break into the industry. Therefore, existing players like ADP can generate oversized profits year after year.
The best part is, ADP is willing to return some of those profits to shareholders in the form of dividends. The company has raised its payout every year for the past 43 years. That makes ADP stock a Dividend Aristocrat—a title awarded to companies with at least 25 consecutive years of annual dividend increases. (Source: “Dividend History,” Automatic Data Processing, last accessed April 19, 2018.)
Earlier this month, the company announced another 10% increase in its quarterly dividend rate to $0.69 per share. This was due to the benefits from the Tax Cuts and Jobs Act in December 2017. Management said that they expect to continue following the annual dividend review schedule and that they anticipate another dividend increase in November 2018. So, shareholders of ADP stock will likely get two dividend hikes this year. (Source: “ADP Increases Cash Dividend,” Automatic Data Processing, April 11, 2018.)
The beauty of owning a top dividend stock like ADP is that investors don’t have to make any decisions on when to sell it. They can just hold onto their shares and let the dividend checks roll in. This is particularly important during market downturns.
For instance, when the stock market crashed in the last financial crisis, ADP stock also took a hit. But during that period, the company was still raising its dividends to shareholders. That gave investors a good reason to hold onto their ADP shares. And as the company’s share price rallied in the years following the stock market crash, investors who did not sell were handsomely rewarded.
Automatic Data Processing Stock Chart
Chart courtesy of StockCharts.com
Automatic Data Processing’s durable business model and growing dividend stream are the main reasons we recommended it to subscribers of our Income for Life advisory back in December 2009. Assuming automatic dividend reinvestment, ADP stock has delivered a jaw-dropping total return of 289% since our recommendation.
Of course, long-term investors are well aware that past performance does not guarantee future results. But if you take a look at what ADP has been doing, you’d see that the company is well positioned to continue its dividend increase track record.
In the second quarter of ADP’s fiscal year 2018 ended December 31, 2017, the company generated $3.2 billion of revenue, representing an eight-percent increase year-over-year. Excluding one-time items, adjusted diluted earnings came in at $0.99 per share, up 14% from the year-ago period. The company also locked in six-percent higher worldwide new business bookings in the quarter. (Source: “ADP Reports Second Quarter Fiscal 2018 Results,” Automatic Data Processing, January 31, 2018.)
At this point, it’s easy to see that the company’s adjusted earnings of $0.99 per share were more than enough to cover its dividend of $0.63 per share declared for the quarter.
What’s more, thanks to these solid results, management is raising its guidance. For full-year fiscal 2018, ADP’s adjusted diluted earnings per share are expected to grow by 12% to 13%. This means the company would generate adjusted earnings of $4.14 to $4.18 per diluted share for its fiscal 2018. If ADP achieves the midpoint of its guidance range, its expected annual dividend of $2.64 per share would translate to a payout ratio of just 63.5%.
Here at Income Investors, we prefer companies that distribute less than 75% of their profits. With a payout ratio of 63.5%, ADP not only leaves a wide margin of safety, it has plenty of room for future dividend increases.
Trading at around $117.75 apiece, Automatic Data Processing has an annual dividend yield of 2.34%. While you can find plenty of higher-yielding stocks in today’s market, ADP’s rock-solid business and dividend growth potential still make it a top pick for income investors.