Many Happy Tax Returns

The screen looks for companies with low PEG ratios. That's a company's price/earnings ratio divided by how fast analysts figure its earnings will increase over the next several years. If a stock has a P/E of 14 and analysts expect the company to boost its earnings by 10% a year over the next five years, its PEG ratio is 1.4. The lower, the better. The broad market has a PEG of about 1.5 right now.

We like the PEG because it normalizes companies' P/E ratios for the differences in growth rates from industry to industry. A cement company and an Internet portal might have vastly different P/Es. But that difference might be fully explained by their growth potential. If so, a look at their PEG ratios might show that the two companies are, in fact, comparably priced.

The last Bargain Growth screen survivors we highlighted was electrical supplier Wesco International (WCC) on March 13 ("Watt a Bargain"). Its shares have since climbed a quick 18%, while the broad market hasn't budged. Use our stock screener and Bargain Growth recipe anytime to run our search for yourself. Recently it produced a list of nine survivors from a starting database of 8,000. Let's look at Jackson Hewitt.

The nation's second-largest tax preparer, Jackson Hewitt produced sales of $253 million over the past year, well less than H&R Block's (HRB) $4.7 billion. But Jackson Hewitt makes money mostly from franchise fees and tax-preparation charges, while a large portion of H&R Block's income comes from mortgages, mutual funds and other financial products. Just how large a portion remains to be seen; the company is in the process of restating its 2004 and 2005 financial results because, all kidding aside, it goofed on its own taxes.

Jackson Hewitt went public for the first time in January 1994 at $15 a share. The stock hit $4 a share in 1996 thanks partly to a change in the IRS's Earned Income Tax Credit that diminished the ability of preparers to — what's a nice way to put this? — skim fat fees off of government cash distributions meant for the poor. But business sharply improved over the next year, and conglomerate Cendant (CD) in 1997 paid more than $68 a share for the company. Jackson Hewitt went public for the second time in June 2004 at $17 a share. The company's performance since has been steady. Shares now fetch $29 and change.

Today the company has 6,000 offices nationwide, most of which are franchised, and more than 1,000 of which operate out of Wal-Mart Stores (WMT) locations. (H&R Block also operates in some Wal-Marts.) It costs just $50,000 to $95,000 up front for franchisees to open a new location. Not surprisingly, Jackson Hewitt has been expanding faster than H&R Block, adding locations at a rate of 12% a year, vs. H&R's 9% a year.

It's also growing its client list faster. On March 13 Jackson Hewitt announced it prepared 11% more tax returns through February than a year ago, and that it expects total returns for the tax season to increase 8% to 10%. H&R Block reported a fractional decline in its number of tax returns through February and said it expects its number of returns for the full tax season to be flat to down 2% vs. last year. Also, Jackson Hewitt's sales per return increased 17% in its third quarter, which ended Jan. 31, three times faster than H&R Block's.

Analysts say H&R's missteps have no doubt benefited Jackson Hewitt. But they also applaud the company's aggressive expansion into under-served markets and its new product offerings. Its pay-stub loan program allowed customers to get refund advances before their W-2 forms even arrived, simply by showing the numbers on their pay stubs (and paying fees that amount to financial assault and battery).

Shares of Jackson Hewitt go for 18.5 times forecasted earnings for fiscal 2006, which ends April 30. The company is projected to increase its earnings per share by 20% a year over the next five years. That gives the stock a PEG ratio of around 0.9, suggesting it's more than a third cheaper than the broad market. Considering the tax code is now 13% longer than it was a decade ago, when Congress last seriously considered tax simplification, we're guessing shares have plenty of upside.