Monday, April 11, 2011

H&R Block: The Panic's Over

Six months ago, the bottom fell out from under the stock of H&R Block (HRB). Shares fell to a 10-year low, giving the stock a normalized P/E of around 7 despite a strong balance sheet. Investors who pounced on the opportunity have seen their shares appreciate by 70%, as the stock closed in on $18 last week. The lessons to be learned from this value play apply to a large number of current and future opportunities.

Many of the problems facing the company were short-term in nature. For one thing, there was a great deal of concern over whether H&R would be able to obtain bank financing for its RAL product in time for this year's tax season. (The product allows individuals expecting a refund to borrow against that anticipated refund.)

Furthermore, there were worries about H&R Block's potential liabilities on improper mortgages it may have issued. While the discovery of these liabilities could result in a large hit to current earnings, the company was capitalized such that it could afford to take a hit of more than 10 times the company's liability estimates and still easily survive, based on the stable, annual cash flows it receives in its core tax-return business.

Nevertheless, the market panic was very real, scaring away many investors. One comment I received after writing about the potential opportunity at the time was as follows:

"The price action of the stock today should say enough. Stay away for now. There are sellers all over the place ready to hit your bid."

The problem with this line of thinking is that it is very bad for portfolio performance! Investing with the crowd is not the way to outperform the market; it is contrarians who beat the market. As such, when everybody else is selling something, that's when your interest level should rise. (Conversely, when everyone else is buying, it's probably a good time to exit.)

What may be even more interesting is that over the last six months, these issues haven't really gone away. Mortgages can still be put back on the company, the company was not able to secure RAL funding, and the company continues to face headwinds with respect to its business model. And yet the multiple at which the company trades now is much more reasonable.

This reinforces the fact that its okay to buy companies with problems; every company faces some challenges, but the ones that make for good investments are cheap and have a financial position such that they can outlast the problems. Rather than focus on the short-term headwinds, therefore, investors should focus on the price they pay versus the long-term value they receive, irrespective of how the market is behaving.

Disclosure: No position

15 comments:

Paul said...

Great job again, Saj!

Don't forget to move this one to the "Value In Action" section! :)

Philbert said...

Thanks Saj.

Good work.

I also liquidated my postion in HRB recently. It's hard to know whether it is worth it to hold on longer for a bit more upside or cash in the chips for another play.

That's the part of investing I find the hardest - knowing when to sell.

One position, in retrospect, that i regret selling is FTP. I bought it at $8 and sold at approx. $21. I pretty much tripled my money in a year. However, the stock proceeded to climb up into the $60 range.

But I guess the stock changed from a value stock to a growth stock and one needs to stick with a value discipline.

Perhaps, I need to do better at setting a price sell target.

Any thoughts on that?

Saj Karsan said...

Thanks Paul and Philbert!

Yeah, Philbert, I understand how you feel about selling; I don't know the best time either.

For one thing though, I like to set price targets beforehand so I'm not influenced by the market later in deciding when to sell. I also like to sell in increments on the way up (kind of the opposite of dollar-cost averaging), so that my risk goes down as the price goes up. Still, I have ended up leaving money on the table in some cases, but in others it has worked out well...I don't really know the best way to do it.

Anonymous said...

I think the issue raised in this post relates to the most troubling part of value investing. The problem is, there's a conflict between momentum and value. Many value investors, myself included, have been frustrated by how frequently our investments initially perform. We "sell shooting stars and buy falling knives". The value investing approach certainly works over the long term, but it's hard to deny the reality that short-term momentum also seems to be real.
-aagikd

Anonymous said...

Saj-
Wasn't the reason H&R Block dropped was the loss of their ability to issue immediate refund loans/debit cards? Did they solve that problem or was the drop in the stock price over done in relationship to the amount of business they would lose from not having that service?
ps
I really enjoy your write ups.

Philbert said...

@Saj

I think, ultimately, it's important to stick with a value discipline. It's impossible to pinpoint the optimal buy and sell points on a stock, but if you stick to your guns, it should work out.

I also think some of investing is just going with your gut; especially if your guts goes against prevaling wisdom. HRB being a good example.

Iowa said...

Saj/Philbert-

I've liquated most of my original holdings, though am still an owner. I have a difficult time talking myself out of the moat they have and the competitive advantage that means. I've heard people have enjoyed Coke products for decades now and most likely will for decades to come. I find it conservative to state that people have had a need for tax assistance in the past and almost certainly will in the future (a bit heavy on the conservative side), though the enjoyable part depends on which side you're on!

Anonymous said...

You were once an owner of GDC.TO. I donot know if you still are. They are being acquired by Jupiter for $5.80 but shares are trading at $4.55 today, Monday. April 11?

Could you please comment? I am a shareholder and I want to know. Thanks

Anonymous said...

Great job Saj, and thanks for the idea on HRB as I benefited from it too!

I know you get these inquiries all the time but I was wondering if GLW ever crossed your radar. It used to be kind of a darling but has lost ~20% of value in recent times (still high off its 52 week low, as well, though). It trades at around 10 times current earnings, 9x projected earnings for next year, has around 3 dollars a share in net cash and is in an industry with explosive growth potential (has a patent on a very high-potential glass that is already used for smart phone screens and makes fiber cable which is speculated by many to be an area of explosive growth in coming years). The management has a conservative history and claimed that they will have double current business in 2-3 years. Sounds like a very cheap stock for all of the growth potential, and even pays a rather solid dividend. Would just be curious if you had any thoughts on it.

Philbert said...

I must add that it was due to your research and blog that i invested in HRB in the first place. So once again, thanks.

Saj Karsan said...

Hi Anon2,

It does not look as though they have solved the problem, but yes it looks like it's only a smart part of their profits.

Hi Anon3,

I haven't looked at GLW, but it looks interesting. If I have any thoughts on it I will post back here.

Saj Karsan said...

Hi Anon,

I have put my latest comments on GDC here.

Saj Karsan said...

Hi Anon3,

GLW does look cheap to me, but it is also complex with a lot of moving parts, including some segments that are out of my circle of competence.

mt said...

Your last paragraph is one of the best I've read in a while.

Keep up the great work.

mt

Saj Karsan said...

Thanks, MT!

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