Yahoo Finance How Does Automatic Data Processing's (NASDAQ:ADP) P/E Compare To Its Industry, After The Share Price Drop?
Unfortunately for some shareholders, the Automatic Data Processing (NASDAQ:ADP) share price has dived 32% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 21% in the last year.
All else being equal, a share price drop should make a stock more attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Check out our latest analysis for Automatic Data Processing
Does Automatic Data Processing Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 21.52 that sentiment around Automatic Data Processing isn't particularly high. We can see in the image below that the average P/E (24.2) for companies in the it industry is higher than Automatic Data Processing's P/E.
Its relatively low P/E ratio indicates that Automatic Data Processing shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's nice to see that Automatic Data Processing grew EPS by a stonking 34% in the last year. And it has bolstered its earnings per share by 16% per year over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Automatic Data Processing's Balance Sheet
Automatic Data Processing has net debt worth just 0.9% of its market capitalization. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On Automatic Data Processing's P/E Ratio
Automatic Data Processing's P/E is 21.5 which is above average (12.7) in its market. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable. What can be absolutely certain is that the market has become significantly less optimistic about Automatic Data Processing over the last month, with the P/E ratio falling from 31.9 back then to 21.5 today. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Automatic Data Processing. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
