On June 12th, this company reported its fiscal year 2013 earnings. Earnings per share were up nearly 25% from last year's numbers. Plus, the company is shareholder-friendly: In 2012, it returned 88% of its free cash flow to shareholders by buying back its own stock.
It also pays a 2.83% dividend. And it has ample cash—nearly $1.8 billion on its balance sheet—almost twice as much as its long-term debt.
Today, we're going to make 14.2% from on H&R Block (NYSE: HRB). It's prepared more than 600 million tax returns since 1955 and has more locations than Starbucks. Even better, we'll do it with a safe 7% cushion. If the market accepts our offer, we'll own a tax giant that prepares one out of every seven U.S. tax returns.
Last tax season, five years of high unemployment caught up with the tax prep industry. With so many Americans not working, the number of tax filings with the IRS fell 0.6%. That doesn't seem like much, but it impacted the entire tax prep industry. Despite this drop, H&R Block's numbers held up—and even grew.
On June 26th, the company released its latest annual report. Even with the decrease in overall tax filings, H&R Block's revenues grew 0.4% from last year, to $2.9 billion. Even with this modest growth in revenue, H&R Block was able to increase net earnings from continuing operations 34.5% from the prior year.
Part of this growth was due to aggressive cost savings, which cut expenses by 4.7% from the prior year. The end result, as we wrote earlier, was a 25% jump in earnings per share. These are strong numbers—despite an atypical year in which IRS filings were down.
But there's one area we want to focus on—the "do-it-yourself" category. I'm referring to tax prep software that helps filers do their taxes from home. About 29% of tax filers in the U.S. are "do-it-yourselfers." Intuit's TurboTax has been the dominant player in this $2 billion market for several years. It has owned 67.5% of the market share.
H&R Block has traditionally been an "assisted" tax prep service—a professional actually sits down and helps you. But H&R Block has recognized the potential in the digital market and has been growing its own online product, H&R Block At Home.
In 2013, these H&R Block online returns grew 11%. This resulted in an online market share increase of 0.5%. H&R Block CEO Bill Cobb was pleased to announce this is the third consecutive year H&R Block At Home has stolen market share from TurboTax.
In the future, we expect to see increasing revenues from its digital service as this market grows. The bottom line is that H&R Block is growing market share and making money. Fortunately for us, it's also returning that money to investors. Last year, the company spent $340 million buying back shares of its own stock. Buybacks act like "secret" dividends. They reduce the number of shares in the market. This makes your shares more valuable.
H&R Block bought back these shares from its free cash flow (the cash left over after covering business expenses, including reinvestment for maintenance and growth). Last year's free cash flow was $384 million. That means H&R Block returned 88% of this cash to investors through buybacks. This is exactly what we want to see.
On top of that, the company pays a dividend with a yield of 2.83% but is H&R Block a good value at its current price? H&R Block trades on the New York Stock Exchange. The average NYSE P/E ratio is 18.5.
["P/E" stands for "price-to-earnings." A P/E ratio tells you how many years of earnings it would take to earn back the total value of your investment. Investors use this metric to determine how cheap or expensive a stock is. You calculate it by dividing the stock price by a company's earnings per share.]
H&R Block's P/E ratio is 17.9. This shows us that the company is fairly valued relative to other NYSE stocks. But a better comparison would be with one of H&R Block's direct competitors. Intuit (which, as we said, makes TurboTax), has a P/E of 21.5.
We find the same result when comparing H&R Block's and Intuit's price-to-sales ratios. These ratios tell us how much we're paying for every dollar of revenue. H&R Block sells at 2.6 times sales. Intuit sells at 4.2 times. People have long quipped, "Nothing is certain but death and taxes." For our purposes today, we're going to turn that into a positive.
Action to take: Sell to Open the H&R Block August 2013 $27 put (HRB130817P00027000)
We've illustrated the annualized returns for three different limit prices below:
The eager limit price of $0.30
The eager limit price is if you want to make sure you execute this trade as soon as possible. You don't mind sacrificing a little of your annualized gain to just get the trade done. You're telling your broker the minimum you're willing to accept is $0.30. That's an annualized return of 10.7%.
The in-between limit price of $0.40
The in-between price is if you want a balance between the other two choices. You don't feel the need to get into the trade immediately. You like the trade, but you don't want to sacrifice too much of the annualized gain just to get a trade executed. You're telling your broker the minimum you're willing to accept is $0.40. That's an annualized return of 14.2%.
The strict limit price of $0.55
The strict limit price is if you don't mind passing up a chance to execute this trade today or the rest of this week. In fact, you could miss the trade altogether, but you want to make sure you get the highest-possible annualized return with your money. You're telling your broker the minimum you're willing to accept is $0.55. That's an annualized return of 19.6%.
[There are two order types, market and limit. If you enter a market order, you are telling your broker to fill the trade at the current market price, whatever it is. If you enter a limit order, you are giving your broker the minimum price you're willing to accept, even if it means you miss executing the trade or have to wait longer to get it filled.]
I recommend that you always check the current market price of the option before entering your trade. Then you can compare the current price of the option to the suggestions I've given you. I gave you three different limit prices to illustrate the annualized returns, provide you with several choices, and give you more control in executing these trades.
To place this trade, you're going to tell the broker, "Sell one put option on H&R Block with a strike price of $27 expiring on August 16th."
You'll receive a minimum of $0.30, $0.40, or $0.55 per share for selling one put option. And since one put option represents 100 shares of stock, you'll get $30, $40, or $55 in cash (less any commissions charged by your broker).
The cash that you will be paid is coming from someone else. He or she is paying you to make a commitment to buy H&R Block from him at $27 per share, with a deadline that expires on August 16, 2013. Plus, the cash you get is yours to keep. You get this cash right after you execute the trade.
The Potential Outcomes of This Trade
If we place this trade, one of two things can happen:
Either H&R Block's stock will be trading below $27 per share on August 16, 2013, in which case, we'll own the stock. You'll keep the money you earned from selling the put option. Your broker will debit your account to purchase 100 shares of H&R Block.
Or H&R Block's stock will be trading above $27 on August 16, 2013, in which case, we won't own the stock. We can immediately make another offer on August 19, 2013, and try to purchase H&R Block again.
[Options expire on the third Friday of each month. That means August 16, 2013, is expiration day. The next trading day is August 19, 2013. That's the earliest we'd be able to sell another put option.]
In both cases, we'll keep the income we've earned.
How Many Option Contracts of H&R Block Should You Sell?
The number of option contracts you choose to sell is an individual decision. It depends on how big your portfolio is and how much H&R Block stock you're willing to own at $27 per share. This means one contract will require $2,700. As a general rule of thumb, you shouldn't tie up more than 20% of your capital in each trade.
The following chart shows the money you'll receive from today's recommended trade, based on the number of contracts you decide to sell versus the amount of capital you'll be required to set aside for selling these H&R Block options.