H&R Block: The Panic's Over

| About: H&R Block (HRB)

Six months ago, the bottom fell out from under the stock of H&R Block (NYSE: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