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The 2 Best Stocks to Own for Tax Season

The opinions expressed by columnists are their own and do not necessarily represent the views of Townhall.com.

It's tax time once again.

For a still-rising number of taxpayers, this means it's time to buy, download or purchase a copy of TurboTax or H&R Block at Home (formerly known as TaxCut), the leading tax-preparation offerings from Intuit (Nasdaq: INTU) and H&R Block (NYSE: HRB), respectively.

These software programs are remarkably similar to each other, and this year's programs look and feel a lot like the offerings from last year. Frankly, it's hard to make a case for one tax software package over the other as they are both quite good.

Yet there is a much more pitched battle when it comes to their stocks. Each company sports a distinct business model and each generates very different financial statements. Which stock is the better buy? Let's find out...

1. Intuit: boringly successful
This maker of Quicken accounting software, along with the top-selling TurboTax, is the equivalent of a Japanese sedan. It never surprises you and delivers the same user experience year after year. With the exception of fiscal (July) 2009, when the weak economy led to just 4% sales growth, revenue has otherwise risen either 11% or 12% in three of the past four years. The outlook for fiscal 2012 and 2013? More of the same.

The rest of the company's income statement is equally predictable. Intuit has generated 30-32% EBITDA margins for seven straight years. The net profit margin appears stuck right at the 16% mark, year after year.

You get the point, the company is pretty predictable.

The question is, are shares of Intuit a bargain? The best metric for these tried-and-true money makers is a PEG ratio (which is the price-to-earnings ratio divided by the projected earnings growth rate). Companies with great brands such as Coca-Cola (NYSE: KO), American Express (NYSE: AXP) -- and Intuit -- typically merit a PEG ratio of between 1.5 and 2.0.

In this respect, shares of Intuit look like a sure bargain. For example, Coca-Cola is expected to boost earnings per share 7% in 2012, and trades for about 17 times projected 2012 EPS of $4.14. That's a PEG ratio slightly above 2.0 (17 / 7 = 2.4). In contrast, with projected profit growth of around 14% in fiscal (July) 2013, and a price-to-earnings (P/E) ratio of around 16.5 times projected EPS of around $3.30, Intuit's PEG ratio is just above 1.0 (16.5 / 14 = 1.17).

2. H&R Block: A messy story gets cleaner
Despite Intuit's ability to pass the PEG test, I think H&R Block carries even more upside -- albeit with more risk. The risk stems from the fact H&R Block is still dealing with some nagging lawsuits related to the recent mortgage crisis. And the company has few fans on Wall Street, because its annual results have been extremely erratic, since H&R Block ventured into niches beyond its core tax business, such as mortgage underwriting.

Moreover, H&R Block looks like a company in decline. Sales peaked at $4.1 billion in fiscal (April) 2008, and are expected to keep falling to below $3.5 billion by fiscal 2013. But you can't forget that looks can be deceiving. Those revenue drops are the result of management's decision to take the company back to its roots and shed all noncore business lines. For example, the company sold consulting firm RSM McGladrey this past August for $610 million. The tax business generates 25% pre-tax margins. McGladrey had 6% pre-tax margins. So that $3.5 billion revenue base represents far healthier margins and predictability than the prior $4 billion revenue base represented.

About a year ago, I discussed H&R Block's anemic sales growth, but also found the shares to be compelling based on the company's hefty free cash flow. Shares have risen more than 30% since then, and I think an additional 30% upside potential remains.

This is because a little-noticed regulatory change stands to help H&R Block finally get the revenue line moving north in coming years. (The consensus calls for a 1% drop in fiscal 2013, but that is likely too bearish.) The change: standards for tax preparers are now much tougher, thanks to recent legislation, which is weeding out a number of unqualified tax preparers out of the business. Some of their customers are likely to flock to H&R Block, either for on-site help, or through the use of the company's software.
Regardless of whether the top line grows -- and how much it grows -- you can be pretty sure that EPS will grow at a nice clip. That's because H&R Block still has $1.2 billion left on a current share buyback plan. Shares outstanding peaked at 339 million in the third quarter of 2009, a figure that currently stands at 300 million. If H&R Block bought another $1 billion of its stock back, then the share count would drop to 240 million. A 20% reduction in the share count instantly yields a 20% boost in EPS -- something investors will likely take notice of, and bid shares up accordingly.

Even before this scenario plays out, shares are already inexpensive at less than 10 times projected 2013 profits. The fact that the stock carries a dividend yield of almost 5% doesn't hurt, either.

Risks to Consider: The biggest risk to both of these stocks is the emergence of a new player that offers tax prep software at even lower price points. No one such entrant currently exists, but the high-margin nature of this business may prove as an enticement.

Action to Take --> Intuit is the "sleep well at night" stock of the two. It has nearly doubled in value since early 2010 and should best be viewed as a solid long-term investment while shares may simply mark time in the near-term after such a solid run. 

H&R Block, on the other hand, is under new leadership (CEO Bill Cobb took the reins seven months ago) and the company's back-to-basics focus on the tax business could unlock solid gains as the business gets more of management's attention. Meanwhile, the low P/E, solid dividend and massive stock buyback makes this the most appealing tax-preparation stock, with at least 30% upside.

D. Sterman does not hold positions in any securities mentioned in this article.
StreetAuthority, LLC does not hold positions in any securities mentioned in this article.

This article originally appeared at www.streetauthority.com.

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