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Should Automatic Data Processing, Inc. (NASDAQ:ADP) Be Part Of Your Dividend Portfolio?

Simply Wall St

Could Automatic Data Processing, Inc. (NASDAQ:ADP) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

A 2.6% yield is nothing to get excited about, but investors probably think the long payment history suggests Automatic Data Processing has some staying power. The company also returned around 1.6% of its market capitalisation to shareholders in the form of stock buybacks over the past year. Some simple analysis can reduce the risk of holding Automatic Data Processing for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Automatic Data Processing!

NasdaqGS:ADP Historical Dividend Yield April 10th 2020

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Automatic Data Processing paid out 58% of its profit as dividends, over the trailing twelve month period. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Automatic Data Processing paid out 60% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

Remember, you can always get a snapshot of Automatic Data Processing's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Automatic Data Processing has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was US$1.32 in 2010, compared to US$3.64 last year. Dividends per share have grown at approximately 11% per year over this time.

It's rare to find a company that has grown its dividends rapidly over ten years and not had any notable cuts, but Automatic Data Processing has done it, which we really like.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. It's good to see Automatic Data Processing has been growing its earnings per share at 17% a year over the past five years. Earnings per share have been growing rapidly, but given that it is paying out more than half of its earnings as dividends, we wonder how Automatic Data Processing will keep funding its growth projects in the future.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. First, we think Automatic Data Processing is paying out an acceptable percentage of its cashflow and profit. Next, growing earnings per share and steady dividend payments is a great combination. Automatic Data Processing has a number of positive attributes, but it falls slightly short of our (admittedly high) standards. Were there evidence of a strong moat or an attractive valuation, it could still be well worth a look.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. Taking the debate a bit further, we've identified 1 warning sign for Automatic Data Processing that investors need to be conscious of moving forward.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.