It’s been about 3.5 months since I made my last bullish call on H&R Block (NYSE: HRB), and meanwhile, stocks returned just under 20% against a loss of around 2.5% for the S&P 500. Obviously, I’m going to indulge my inner “pompous breath” and brag about this performance, but I think there’s a more compelling reason to revisit that name. A stock trading at $26 is by definition a riskier investment than when that same stock is trading at $22, so I need to revisit the name. It’s tedious on one level, but success requires reassessment. I will decide whether or not it makes sense to buy, sell or hold based on recently released financial data and considering the stock as something separate from the underlying business. Also, I wrote the January 2023 puts with a $15 strike, and I’m desperate to see this trade again for two reasons. The most important reason is that it gives my fragile ego another chance to brag. Oh, and this trade also gives me the opportunity to remind investors of the powerful risk-reducing and yield-enhancing potential of short put options in general. I warn you in advance, dear readers. Get ready for a tedious bragging fest with this one.
If it’s not obvious to you after reading the paragraph above, I’ll spell it out explicitly. My writing can be very boring to skim. I’m not too heartless, though, and so I’m offering people a way to get the gist of my arguments in a single summary paragraph at the start of the article. I’m doing this so you don’t have to wade through the “heart of darkness” which is the rest of this article. Here is. I will be selling my H&R Block today because I am not comfortable with the combination of weak financial performance and relatively rich valuation. As for my put options, I would be comfortable if the stock was “sold” to me at a price around 44% below the current level. For this reason, I will not do anything with those. Nothing, that is, except bragging about performance. That’s my thought in a nutshell. I warned you how tedious I can be, so if you read on, any nausea or trauma you suffer from is your responsibility.
I would say that the latest financial results have been disappointing. Compared to the same period a year ago, revenue was down about 37% and net profit was down $24.2 million. Despite this, the dividend increased by 3.85%. Additionally, I think it’s worth noting that operating cash also declined dramatically over the period, down about $21 million or 30% from the time of year. previous.
It’s not all frowns and rain clouds at H&R Block, though. The capital structure improved quite dramatically, with long-term debt down $269 million from the comparison period.
Please note that when it comes to the capital, we are not comparing apples to apples. The most recent period is the six-month period ending on December 31, 2021. The previous period ends on January 31, 2021. This calendar change is linked to the Council’s decision of June 9, 2021 to change the end of the fiscal year from April 30 to June 30. While the “flow” activities in the income and cash flow statements are comparable, the “point in time” comparisons in the balance sheet relate to slightly different periods. For my part, I am comfortable comparing the December 2021 capital structure to the January 2021 capital structure.
Given this deterioration, I would need to see the stock trading at a large enough discount to my previous entry price for me to be enthusiastic about adding more.
If you regularly read my articles, you know what time it is. That’s when I go from a “depressing” to a “total depressing”. This is the point in the article where I start writing about risk-adjusted returns and how any stock can be a terrible investment at the wrong price. Specifically, the company can make a lot of money, but the investment can still be terrible if the shares are too expensive. Indeed, this business, like all businesses, is an organization that takes a bunch of inputs, adds value to them, and then sells them for a profit. That’s all a business is in the final analysis. The stock, on the other hand, is a proxy whose changing prices reflect the ever-changing mood of the crowd more than anything to do with the company. In my opinion, stock price swings are much more about expectations about a company’s future and the whims of the crowd than anything to do with the company. Our goal as investors is to spot the gaps between expectations and subsequent reality. This is why I view stocks as separate things from the underlying business.
If you were hoping that I was just going to make this point and move on, prepare for very big disappointment, dear readers. I will demonstrate the importance of viewing inventory as a separate thing from business using H&R Block itself as an example. The company released its latest quarterly results on February 4. If you bought that stock that day, you are up about 6.5% since then. If you waited until April 25 to pick a date completely at random, you’ve been down about 10% since then. Of course, not much has changed within the company in this short period of time to justify a 16.5% difference in returns. The differences in yield came down entirely to the price paid. Investors who bought virtually identical stocks at a lower cost did less harm than those who bought the stocks at a higher price.
My regulars know that I measure the cheapness (or not) of an action in several ways, ranging from the simplest to the most complex. From a simple perspective, I’m looking at the relationship between price and some measure of economic value like sales, profit, free cash flow, etc. Ideally, I want to see a stock trading at a price below both its own history and the broader market. In my previous missive, I was excited when stocks were trading at a price-to-sell ratio of around 1.2. They are now around 15.4% more expensive, based on the following criteria:
In addition to simple ratios, I want to try to understand what the market is currently “assuming” about the future of this company. To do this, I turn to the work of Professor Stephen Penman and his book “Accounting for Value”. I’ve heard some people in my so-called “real world” say this book is a bit too academic, and you might want to check out “Expectations Investing” by Mauboussin and Rappaport, a book that reviews the same ideas of a little more accessible way. Either way, the idea is to determine what the market “thinks” about the future growth of a given company. This is to isolate the variable “g” (growth) in said formula. Applying this approach to H&R Block at the moment suggests that the market is assuming that this company will grow around 2% in the long term. Given that revenues have grown at a CAGR of only around 1.5% over the past 8 years, this is actually a pretty optimistic forecast in my opinion. Given the above, I remove my chips from the table here.
A few months ago I sold the January 2023 puts with a strike of $15 for $0.78 each. As of today, these put options are now offered at $0.25, so the trade worked out pretty well in my opinion. In fact, on a percentage basis, they’ve done even better than the stocks I bought a few months ago. So I sold put options that were out of the money at the time, and they lost about 67% of their value. In my opinion, this is yet another example of how short put options reduce risk while enhancing returns.
Although I normally like to try to repeat success, I cannot in this case because the bonuses offered for reasonable strike prices are too slim in my opinion. See the $0.25 bid on January 2023 as an example of this phenomenon. For this reason, I conclude that there is nothing to do here.
In my opinion, the financial performance has been quite poor lately. If stocks remained cheap despite this, that would be fine with me, because every company is going through a tough time. The problem for me is that stocks have soared despite this performance. For this reason, I remove some of my chips from the table. Specifically, I’m selling all of my H&R Block stock, while keeping my put options. I may miss some benefits, but I remember the first two rules of investment success. First rule: do not lose capital. Rule two: Remember rule number one.