Automatic Data Processing, Inc. (NASDAQ: ADP) Share Price May Signal Risk

With a price / earnings (or “P / E”) ratio of 36.6x Automatic Data Processing, Inc. (NASDAQ: ADP) can send some very bearish signals right now, given that almost half of all companies in the United States have P / E ratios below 17x and even P / E below 9x are not unusual. However, the P / E can be quite high for a reason and requires further investigation to determine if it is warranted.

The recent times have not been good for automatic data processing, as its profits have grown more slowly than most other companies. One possibility is that the P / E is high because investors believe this poor earnings performance will improve dramatically. You really hope so, otherwise you are paying a pretty high price for no particular reason.

NasdaqGS: ADP price based on past earnings November 26, 2021
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Is there sufficient growth for automatic data processing?

There is an inherent assumption that a business would have to far outperform the market for P / E ratios such as automatic data processing to be considered reasonable.

In retrospect, last year generated a decent 9.8% gain in the company’s bottom line. This was supported by a great period before seeing BPA increase by 42% overall in the past three years. As a result, shareholders would likely have welcomed these earnings growth rates over the medium term.

Looking to the future, estimates from analysts covering the company suggest profits are expected to grow 9.8% annually over the next three years. This is shaping up to be similar to the forecast for growth of 11% per year for the broader market.

With this information, we find it interesting that Automatic Data Processing is trading at a high P / E relative to the market. Apparently, many investors in the company are more bullish than analysts indicate and are not willing to give up their shares just yet. However, further gains will be difficult to achieve as this level of earnings growth is likely to weigh on the stock price eventually.

The last word

We would say that the power of the price / earnings ratio is not primarily as a valuation instrument, but rather to gauge current investor sentiment and future expectations.

Our review of the Automatic Data Processing analyst forecast revealed that its earnings outlook comparable to the market is not having as much of an impact on its high P / E as we would expect. When we see the outlook for average earnings with growth similar to that of the market, we think the stock price may go down, pushing the high P / E down. This puts shareholders’ investments at risk and potential investors risk paying an unnecessary premium.

Another key area for risk analysis is the company’s balance sheet. Our free Balance sheet analysis for automatic data processing with six simple checks will allow you to discover the risks that could be problematic.

It’s important to make sure you research a great company, not just the first idea you come across. So take a look at this free list of interesting companies with recent strong earnings growth (and a P / E ratio of less than 20x).

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.

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