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Automatic Data Processing (ADP) Has Fallen 19% in Last One Year, Underperforms Market

Alex Smith
·6 min read

If you are looking for the best ideas for your portfolio you may want to consider some of Pershing Square Capital Management's top stock picks. Pershing Square, an investment management firm, is bearish on Automatic Data Processing Inc (NASDAQ:ADP) stock. In its Q2 2019 investor letter – you can download a copy here – the firm discussed its investment thesis on Automatic Data Processing Inc (NASDAQ:ADP) stock. Automatic Data Processing Inc (NASDAQ:ADP) is a provider of human resources management software and services.

On August 13, 2019, Pershing Square had released its Q2 2019 investor letter. The investment firm said that Automatic Data Processing Inc (NASDAQ:ADP) was one of the biggest contributors to its performance for the first six months of 2019. The stock has posted a return of -19.2% in the trailing one year period, underperforming fund's benchmark the S&P 500 Index which returned 22% in the same period. This suggests that the investment firm was right in its decision to sell Automatic Data Processing Inc (NASDAQ:ADP) stock in Q2 2019. On a year-to-date basis, Automatic Data Processing Inc (NASDAQ:ADP) stock has fallen by 17.9%.

Pershing Square fund posted a return of 45.3% during the first half of 2019, outperforming fund's benchmark the S&P 500 Index which returned 18.5% in the same period. Let’s take a look at comments made by Pershing Square about Automatic Data Processing Inc (NASDAQ:ADP) stock in the Q2 2019 investor letter.

"During the last several weeks, we sold our stake in ADP. Although we expect ADP to continue to do well over time as the company executes on its business transformation, we view the prospective returns from today as more modest because the market is now more accurately pricing in ADP’s prospects for success.

We achieved many of the objectives we established when we initiated our position in ADP. This led to a highly successful investment outcome particularly considering the low-risk and unleveraged nature of ADP’s business. At the time of our exit, approximately two years from the establishment of our position, ADP’s stock price had increased to $167 per share, generating a total shareholder return including dividends of 64%, more than double the S&P’s total return of 30% over the same period.(11) Including the benefit of leverage in the form of long-dated, very-deep-in-the-money call options that were used to finance a portion of this investment, PSH realized returns in excess of the stock return, culminating in an attractive 40% annualized rate of return.

Prior to our investment, ADP was not well understood by the investment community, and garnered little critical attention. While the company participates in an excellent industry and had produced good shareholder returns over time, its performance was well below its structural potential.

While our original approach was to work quietly behind the scenes to achieve our investment objectives, we were quickly forced into a proxy contest which led us to publicly air our concerns and the opportunities we had identified. During the contest, we were able to successfully make the case to shareholders that ADP had the potential to materially improve its competitive position, generate higher revenue growth, and achieve substantially greater efficiency and margins while enhancing the customer experience.

Our activism bore significant fruit. ADP’s investor base emerged from our engagement better educated about the company’s enormous potential. With the support for change from other major shareholders, we were able to catalyze the company to embrace a business transformation. As a direct result of our activism, ADP made commitments to accelerate revenue growth, bolster its competitive position in the Enterprise market, and improve efficiency and margins.

During the past year, management started to execute on these new commitments by accelerating existing efficiency initiatives and embracing new projects to streamline ADP’s business. These initiatives have included: (1) accelerating the development of ADP’s next-generation platforms, (2) broadening and accelerating the company’s Service Alignment Initiative, (3) launching an early retirement program, (4) executing a broad-based workforce optimization effort focused on spans of control and management layers, and (5) launching an accelerated procurement transformation effort aimed at thirdparty vendors and internal expense management. These projects, along with other smaller initiatives underway, allowed ADP to realize significant margin expansion and earnings growth in the fiscal-year ended June 30, 2019. These initiatives should provide a tailwind for continued operating progress over the coming years. ADP’s business transformation has been accomplished as the company continues to post near-record client retention and accelerated bookings and revenue growth, demonstrating that customers are supportive of the changes.

At the time we invested in ADP, the company was forecasting approximately $3.80 of earnings per share in fiscal-year 2018. Recently, ADP has provided earnings guidance of $6.10 to $6.20 for fiscal-year 2020 (ADP’s fiscal year ends June 30th), and ~$7 per share of earnings in fiscal year 2021, an ~85% increase in earnings per share in three years if ADP meets its projections which historically have been conservative.

Furthermore, we believe that there continues to be a significant opportunity for ADP to execute its ongoing business transformation in the years ahead, and to expand margins and earnings beyond current targets, but best-in-class execution will be required. If ADP meets its 2021 earnings targets, we estimate the stock will generate a low double-digit return from our exit price. While we believe now was the appropriate time to sell our investment in ADP, we wish the company well as it continues its business transformation."

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In Q2 2020, the number of bullish hedge fund positions on Automatic Data Processing Inc (NASDAQ:ADP) stock increased by about 7% from the previous quarter (see the chart here), so a number of other hedge fund managers don't seem to agree with ADP's downside potential. Our calculations showed that Automatic Data Processing Inc (NASDAQ:ADP) isn't ranked among the 30 most popular stocks among hedge funds.

The top 10 stocks among hedge funds returned 185% since the end of 2014 and outperformed the S&P 500 Index ETFs by more than 109 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds' poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Below you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.

Video: Top 5 Stocks Among Hedge Funds

At Insider Monkey we scour multiple sources to uncover the next great investment idea. We go through lists like the 10 most profitable companies in America to pick the best large-cap stocks to buy. Even though we recommend positions in only a tiny fraction of the companies we analyze, we check out as many stocks as we can. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. If you want to find out the best healthcare stock to buy right now, you can watch our latest hedge fund manager interview here. You can subscribe to our free enewsletter below to receive our stories in your inbox:

Disclosure: None. This article is originally published at Insider Monkey.