Et tu, Eliot?H&R Block ( HRB) investors received a rude awakening on the Ides of March. On March 15, New York Attorney General Eliot Spitzer filed a $250 million civil lawsuit against the country's largest tax preparer, claiming the company was charging exorbitant fees for its "Express IRA" service. H&R Block, which prepares 20 million tax returns each year, sold this product to some 500,000 of its clients, allowing them to roll expected tax refunds into retirement accounts. The stock fell nearly 7% on March 15 and is off 14% for the year at Tuesday's closing price of $21.13. This slide comes after H&R Block generated a 13.9% compounded annual total return for investors over the past five years. The company's earnings trajectory has seen a similar descent. After growing per-share profit at a compounded annual growth rate of 29% from 1998 to 2004, H&R Block is on track to post its second straight annual earnings decline in 2006. So should readers buy H&R Block at Tuesday's closing price? In other words ( let's all say it together!), should I do it?
Adding insult to injury, the Spitzer suit doesn't represent the first time the company has run into legal trouble. Just in December, H&R Block settled class-action suits across 26 states for $62.5 million claiming that the company falsely marketed its pre-refund loans. On Feb. 15, California Attorney General Bill Lockyer filed similar claims. The bulls will argue that H&R Block sports a hefty 2.3% dividend yield, some 50 basis points above what the average S&P 500 stock offers. The company has raised its payout every year since 1998 and can comfortably cover the payment 3.4 times with expected 2006 earnings of $1.70 a share. According to the latest Securities and Exchange Commission filings, Warren Buffett's Berkshire Hathaway ( BRK.A) was one of H&R Block's largest shareholders. Buffet still controls 5.7% of the company, though Berkshire sold a third of its stake last summer. How can you bet against the Oracle of Omaha, right? I admit, H&R Block's 12.4 price-to-earnings ratio is attractive on the surface. But what this valuation doesn't reflect is just how much the company's business will be affected by the New York attorney general's investigation. Just ask Marsh & McLennan ( MMC), whose insurance business and share price have not been able to sustain any type of recovery since Spitzer probed the company's sales-kickback program. In my opinion, the fact that H&R Block's earnings and legal problems don't seem to have spread to anyone else in the industry does not bode well for the stock's near-term performance. If the company lost market share because of some technical glitches earlier this year, what's to stop other folks from jumping ship to one of several competitors, large and small, that offer a similar service at a similar price? In H&R Block's business, a trustworthy image is very important, and I believe the company's reputation has been tarnished by the multiple issues mentioned above. With that in mind, readers should avoid the stock at current levels, as it may continue to trend lower into the high teens over the coming months.