Are Strong Financial Prospects The Force That Is Driving The Momentum In Automatic Data Processing, Inc.'s NASDAQ:ADP) Stock?

Automatic Data Processing's (NASDAQ:ADP) stock is up by a considerable 6.2% over the past month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Automatic Data Processing's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Automatic Data Processing

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Automatic Data Processing is:

42% = US$2.5b ÷ US$5.9b (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.42.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Automatic Data Processing's Earnings Growth And 42% ROE

First thing first, we like that Automatic Data Processing has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 14% which is quite remarkable. This likely paved the way for the modest 12% net income growth seen by Automatic Data Processing over the past five years. growth

Next, on comparing Automatic Data Processing's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 11% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Automatic Data Processing's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Automatic Data Processing Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 59% (or a retention ratio of 41%) for Automatic Data Processing suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Automatic Data Processing is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 52% of its profits over the next three years. As a result, Automatic Data Processing's ROE is not expected to change by much either, which we inferred from the analyst estimate of 42% for future ROE.

Summary

Overall, we are quite pleased with Automatic Data Processing's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. 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.
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