Greg Guenthner discusses two Tax Preparation companies and their Stocks: Giant H&R Block, and up-and-coming small-cap Jackson Hewitt.

It’s that time of year again. The W-2s have been mailed and everyone is searching for receipts and bank statements.

Almost everyone is familiar with tax preparation giant H&R Block. When it comes to having someone do your taxes for you, chances are you see H&R Block first. But there’s another, much smaller company out there you need to be aware of.

In fact, this small-cap tax adviser has been slowly gaining market share, drawing new customers and even some away from Block. Although it’s not time to snap up shares of this stock just yet, it’s important that you keep an eye on this company.

First, there’s H&R Block (HRB: NYSE), the $8.1 billion tax preparer. Block operates out of more than 9,000 tax offices and 98 financial centers in the United States. And it also has overseas offices — 1,000 in Canada, Australia and the United Kingdom. Block’s Web site claims that the company serves more than 19 million taxpayers across the world.

But over the past few weeks, I’ve noticed tons of new billboards and television spots for another tax preparer, Jackson Hewitt.

Tax Preparation Stocks: A Small-Cap Prepares Big Taxes… and Big Profits

As it turns out, Jackson Hewitt Tax Service Inc. (JTX: NYSE) is the second largest tax preparation service company in the country. The company has more than 5,400 franchised and company-owned offices across the country, filing more than 3.3 million tax returns a year. Yet it is still a small-cap company. And it’s still a whole lot smaller than H&R Block — weighing in at just $898 million.

Hewitt has fared decently in trying to steal market share from Block. Here’s some analysis from the Kansas City Star:

“[H&R Block’s] approximately 20% market share among taxpayers who seek professional help with their returns has remained essentially flat or fallen slightly each year since 2002. Block has faced increased competition from Jackson Hewitt Inc. and Liberty Tax Service and a greater availability of free filing programs and more sophisticated software for do-it-yourselfers.”

And JTX has an extensive ad campaign running now to try and grab even more customers

“We’ve put more than $15 million behind our ad campaign, with hard-hitting television commercials, radio announcements, direct mail and billboard,” said the JTX marketing team in a statement posted on the company’s Web site.

It’s even forked over big money for popular and unique sponsorships:

“[The company has a] sponsorship with the Professional Bowlers Association (PBA).” It’s also “joining the National Guard, Subway and Travelodge to sponsor the No. 16 Ford Taurus Race Car, driven by Greg Biffle, in the Nextel Cup Series of NASCAR 2005…We’re confident that these high-profile sports sponsorships will drive consumer awareness and retail traffic as a result of our national consumer promotions, strong media buys, public relations efforts and local marketing programs.”

Tax Preparation Stocks: How Jackson Hewitt Could Bring in Big Returns

Also, in order to keep the publicity machine spinning, the company encourages franchise owners to actively plug away. In 2005, the company says it generated nearly $1 million in free promotional announcements (through on-air interviews, positive news stories, etc.).

So the ad-blitz could help Jackson Hewitt gain some much-needed name recognition, possibly even helping to steal some more customers away from the Block — although it will be impossible to tell until after the chips are counted this summer.

Advertising aside, Hewitt has performed well since the company went public in summer 2004. The stock is trading for $25.35, down from a recent 52-week high of $28.30.

Hewitt’s annual net income is up to $53 million for 2005, up from $43 million in 2004. Like Block, Hewitt rakes in its profits in the third and fourth quarters of the year, then loses some money in the quiet non-tax seasons of the fall and winter.

However, since the company doesn’t have a long track record for comparison, a poor showing in its second tax season as a public company could cause its share price to take a big hit.

And then there’s H&R Block’s answer to its stagnant market share.

Block’s CEO said earlier this month that the company hopes to turn things around by “opening a record 12,200 U.S. outlets this tax season,” according to the Kansas City Star. If Block continues to saturate the market like this, it will be difficult for Jackson Hewitt to swipe more customers from the frontrunner.

And with taxes on most people’s minds, we could also see some heavy volume for both Block and Hewitt, inflating the share price for the season. I think it’s best to watch the young JTX for a while to see if it gets its footing this spring during its second tax season as a public company.

I’ll keep an eye on JTX this summer when second earnings from tax season are reported. By then, we’ll be able to see if Hewitt really can spend the shareholder’s dime, or whether all those billboards and ads were a complete waste of cash.

Until next week,

Gunner
January 30, 2006

P.S. At Sleuth Headquarters, we’re always looking for a good stock that’s selling at a bargain price. Coincidentally, Jackson Hewitt fits the profile of a Million Dollar Portfolio pick — stocks we recommend in Penny Stock Fortunes with high return on capital trading at cheap prices. It has a high combined earnings yield around 8% and return on invested capital of more than 100%. These combined metrics rank Hewitt as one of the top 100 stocks in the country with market capitalization over $50 million. The high ROIC shows that Hewitt has known how to spend shareholder money wisely to grow its business recently. We’ll keep this in mind in the months to come.

Greg Guenthner

Greg Guenthner heads up Agora Financial’s small-cap division and is the founder of one of the only independent OTC research advisories in the industry. A graduate of George Mason University, Guenthner joined Agora in 2005 after several years as a journalist. He is managing editor of Penny Stock Fortunes and Bulletin Board Elite.

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