Automatic Data Processing (ADP), Paychex, Inc. (PAYX): These Two Industry Leaders Are Fully Valued

Lofty valuations a cause for concern

ADP recently reported a solid fiscal third quarter, in which revenue and earnings per share from continuing operations increased 7% and 9%, respectively. Taking a longer-term view, the company’s revenue and diluted earnings per share have grown 6% and 5.7%, respectively, through the first nine months of the fiscal year.

Those numbers are certainly respectable, but judging by its immense share price appreciation, you’d think ADP was a high-growth start-up. The stock is up more than 25% just to start 2013, and as a result, the company now trades for 25 times its trailing earnings per share.

Paychex has a similar story to tell, since it also trades for 25 times trailing earnings thanks to a 24% rally in the company’s share price since the beginning of the year. Paychex’s third quarter results compared similarly to ADP: the company realized 4% growth in total service revenue and 8% growth in diluted earnings per share.

As I mentioned before, these two companies are well-managed and highly profitable. But when you consider the lofty valuations these companies enjoy, due to their huge run-ups in price over the past few months, and you have more than enough reason to hesitate before jumping in to these stocks. Savvy investors would be wise to wait for a meaningful pullback before buying these two stocks.

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