Automatic Data Processing, Inc.'s (NASDAQ:ADP) Popularity With Investors Is Under Threat From Overpricing

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Automatic Data Processing, Inc. (NASDAQ:ADP) as a stock to avoid entirely with its 28.9x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Recent times have been pleasing for Automatic Data Processing as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Keen to find out how analysts think Automatic Data Processing's future stacks up against the industry? In that case, our free report is a great place to start.

What Are Growth Metrics Telling Us About The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Automatic Data Processing's is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 14% last year. This was backed up an excellent period prior to see EPS up by 50% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 9.5% per annum as estimated by the analysts watching the company. With the market predicted to deliver 10% growth each year, the company is positioned for a comparable earnings result.

In light of this, it's curious that Automatic Data Processing's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

What We Can Learn From Automatic Data Processing's P/E?

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Automatic Data Processing currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Automatic Data Processing with six simple checks will allow you to discover any risks that could be an issue.

If these risks are making you reconsider your opinion on Automatic Data Processing, explore our interactive list of high quality stocks to get an idea of what else is out there.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.