Buffett Loves It. Skippers Say It's Cheap. It's Up 21%. Name That Stock.

H&R Block(HRB) is something of an anomaly.

When everyone else in America is fretting about taxes, the company is whistling It's the Most Wonderful Time of the Year: Last year H&R Block prepared a whopping one out of every seven tax returns filed with the IRS, serving about 17 million tax clients in the U.S.

But it's an anomaly for other reasons, too. It's one of a select group that can claim earnings visibility, and its growth rates look solid. In January the company forecast annual revenue growth of 10% to 15%, with expected EPS growth of 13% to 18%. In light of that visibility the stock has held up well this year, gaining 21% in a 13-week period. Not only that, but it has attracted the eye and wallet of no less than Warren Buffett, whose Berkshire Hathaway is now the second-largest holder and also a rumored acquirer of H&R Block.

And here's the best part: Many fund managers say the stock's still cheap. If the company does a better job running some of its nontax operations in its bid to become a full-service financial-services company, it may be worthwhile for investors to pull their heads up from their 1040 forms and check out this stock.

Big Block H&R Block's growth levels in sales, profit and EPS have all beat the market in one- and three-year periods
	1-Year* Growth, H&R Block	3-Year* Growth, H&R Block	3-Year* Growth, S&P 500
Sales	49.1%	32.0%	11.2%
Net Income	17.0	74.1	13.8
EPS	19.2	78.3	14.2
* Figures for trailing growth. Source: Morningstar.

"It's one of the stocks that's helped me not to lose a lot of money this quarter," says Jerome Heppelmann, who manages two funds for PBHG that count H&R Block among the top holdings.

On the downside, the company's recent attempts to transform itself into a financial-services company have fallen a little flat, and detractors point to its tendency to lose money three out of four quarters in the year, outside the tax season.

But some investors say that's no different from many retail companies that make the bulk of their profits during the holiday season. And they believe H&R Block is relatively well-positioned to withstand an economic downturn, given the steady nature of its business. "Taxes don't go away," sums up PBHG's Heppelmann. He thinks it's unlikely that newly price-sensitive consumers will revert to doing taxes themselves -- in fact, the company could conceivably pick up more business as people reject more expensive CPAs in favor of its cheaper services.

Nor is he overly concerned about competition from the likes of Intuit(INTU), which leads the market for online tax services. "There's room for two in both the offline and online space," he says.

The arrival of new management during the past couple of years gives hope to other investors. "We have confidence that this management group is going to be smarter about deploying cash. We expect to see more share repurchases and a lot fewer acquisitions," says Henry Berghoef, co-manager of the (OAKLX)Oakmark Select fund, who criticized H&R Block's pricey acquisition of a discount brokerage two years ago. "This is a company that has, in terms of its core business, performed quite well. But with a more aggressive, sharper management team, there's plenty of room to improve the growth rate of both revenues and EPS."

The number of tax returns filed annually has increased by only about 1.5% a year during the past two decades. But Berghoef thinks H&R Block should be able to increase revenue to the low double-digits going forward, with earnings growth in the midteens. That could happen if the company continues to take market share from competitors and improve its marketing, stressing H&R's ability to handle complex tax problems. A key piece of that strategy will be bringing in more high-income customers. H&R Block's current clientele is mostly middle- and lower-income folks. (The company garnered some bad press recently when a federal judge found it had used deceptive advertising in a refund-anticipation loan plan aimed at low-income clients. H&R Block was ordered to pay out half a million dollars to a competitor.)

Investors have followed the progress of President Bush's proposed $1.6 trillion income tax cut with enthusiasm because a change in tax law might benefit the stock. "Historically, there's been a good correlation between changes in the tax code and a pickup in business for H&R Block," says Michael Hodes, an analyst at Goldman Sachs.

Theoretically, the potential also exists for Congress to simplify the tax code, which would make it easier for people to do their own taxes and stand to hurt the tax preparation business. But nobody expects a flat tax or its like to be approved any time soon.

Though tax services still provide the bulk of operating earnings, during the past few years H&R Block has pushed into new areas of business, including mortgage originations, investing services and accounting. As part of that strategy, in 1999 it acquired Olde Financial, parent of the fourth-largest discount broker in the U.S., and McGladrey & Pullen, an accounting and consulting firm.

By most accounts, H&R Block's foray into nontax businesses hasn't been a ringing success. "To date, H&R Block has yet to really demonstrate the synergistic benefits of their nontax businesses," says Hodes. Agrees Heppelmann, "Some of the acquisitions that they've tried to combine with their core tax prep business really haven't done that well. I'd argue that's very well-known and [reflected] in the stock price, but it could be considered a negative."

But given those problems, some investors think there are easy pickings to be made if the company starts to execute better, using its offices to sell other services in the tax off-season. For several years the company has lost money for three out of four quarters -- basically, the entire year outside of tax season. This year it was profitable for the first time ever in the fiscal third quarter (ending in January), helped along by unusually early tax business and contributions from nontax business like mortgages.

The stock is now trading near its 52-week high, having closed Friday at $50.05, only a notch below its peak of $52.39 on March 8. But fund managers say it's still an appealing valuation. They point out that H&R Block's actual cash earnings are significantly higher than its reported earnings, which reflect the cost of goodwill amortization from its acquisitions. Here's Berghoef's reasoning: For next fiscal year -- the year that ends April 30, 2002 -- analysts are forecasting earnings of about $3.25 a share. Adding back 90 cents a share in intangible amortization, you get $4.35 in earnings. With the stock at roughly $50, that makes for a price-to-earnings ratio of about 12 times. "That looks significantly lower than the market multiple, for a company we think is better than the average company," he says.

Discount Block Based on current and forecast earnings, H&R Block trades at a discount to the market
	H&R Block	S&P 500
Price/Earnings*	20.7	25.6
Forward P/E	17.4	21.3
* Earnings based on estimates from Zack's Investment Research. Source: Morningstar.

H&R Block seems to think so. In March 2000 the company announced it would buy back 12 million shares of its stock. To date, it's purchased 7.2 million shares.

In another big vote of confidence, Warren Buffett disclosed in February that he'd bought up 8.43% of H&R Block, making him the second biggest owner of the company, after Fidelity. That prompted rumors that Buffett could view the company as a takeover target. The company's 9,000 retail offices nationwide could theoretically be used to distribute insurance for Berkshire Hathaway subsidiaries.

Buffett didn't respond to speculation. But even if the rumors are false, his well-known bargain-hunting abilities might give anyone interested in H&R Block something to think about.

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