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HRB - fear of financial stock

11/30/2004

HRB

Sold out recently

Today the Blast Investor Model Portfolio hit record high with more than 50% of gain year to day. I have sold HRB days ago in the model portfolio so that I want to talk about more detail about the rational to exit HRB investment.

I have invested in HRB for a little over a year and exited it with loss. In summary, I sold out HRB because of the poor mortgage business in recent earning. I should confess that the deeper reason was due to my fear or distrust of financial stock in general.

HRB - a me-too mortgage business or a unique type of mortgage business?

Mortgage business is usually very competitive. Banks compete for customers with lower rates and fees. Mortgage business is also very rate-sensitive business in general. When interest rate goes up, people will  be less likely  to buy expensive houses and they will buy more cheaper houses or mobile homes or directly go for renting.

HRB mortgage is supposed to be rate insensitive by focusing on non-prime mortgage and targeting poorer consumer in general. HRB mortgage is supposed to have unique mortgage business model so that it would make "flat earning" this year when interest rate goes up. That was the message that I heard from HRB management again and again until this earning report.

Now, the mortgage earning will go down and mortgage earning will drop by -30%. The reason is now due to "too much competition" in mortgage business.

If we look at many mortgage company such as country-wide etc, we can see that their recent earnings are all pretty bad. The same old story that interest rate is really hurting their business because refinance of mortgage business dropped dramatically as rate goes up.

My take on HRB mortgage business - I do not believe them

My take from the recent HRB earning report and conference call is that HRB is just a me-too business in terms of mortgage business. There might be potentially very dangerous refinance component or some unknown part hidden in HRB mortgage business.

Let's look at other mortgage companies that focus mainly on non-prime mortgage market, such as Accredited Home Lenders Holdings  (symbol LEND). This company LEND reported better than expected mortgage earnings recently and  sees earning growth at 15% ahead. This makes sense if we rationalize the positive rate effect on poorer component of market. However, this is opposite of what I see in HRB's mortgage business.

My Rule No 1:  move on if I can not figure out

Financial business is very hard to understand.  HRB mortgage business is such difficult business I can not understand right now.   Only 3 months ago "competition" was not problem and but now it is the problem according to management.  It could be that my suspicion is not warranted and HRB mortgage business is fine. However, here is my rule No.1 for the Margin of Safety: move on if I can not figure out the business even if I need to sell at loss, even if I could be wrong to miss a good stock.

HRB vs SOHU

HRB now is similar to SOHU's situation before. HRB mortgage is in downturn while tax business is very good while SOHU wireless part is bad and ads business is very good.  The big difference is that SOHU ads business growth rate is much higher and HRB tax business growth is not high enough to compensate the mortgage business part. They both have high price to book ratio so that the risk is still there. As all of you already know from my earlier article, I evaluate risk more by asset level rather by earning alone. This risk of high price to book ratio of HRB is part of reason I sold.

Overall, HRB is not really bad stock. It is decent good stock with some problems. However, because I have so much other better stocks and potentially I may find better pick as I did in USG, I will move on with loss here.

Selling at loss is not problem

Lots of time I find many people have trouble of selling at loss. They want to wait for breaking-even. This break-even mindset is not good for successful investing.  Personally I myself do not care about selling at loss or gain in individual position. If my record on HRB was gain, I probably would have sold too.

Look, there is no way to make profit in every stock pick. However with diversification and careful stock picking with right strategy, the loss in the overall portfolio can be very minimum.

Subscriber Question on "surplus" account

Question: 

I am reading the "Security Analysis" book. Benjamin Graham kept illustrating cases in which companies charge costs against the "surplus".  Is this "surplus" account  same as "retained earnings" in balance sheet?


My answer:

"Surplus" item is not same as  "retained earnings".  "retained earning" is standard accounting item.  "Surplus" is an extra accounting item set aside by company.  Another item called "reserve account" is also used by many company, which many times is similar to "surplus" called by Ben. 

I hope my above answer helps you. If you have further questions, please feel free to ask me and I usually will answer directly to you. If the question is newsletter related to larger readers, I will answer in the next newsletter issue.

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In the next 2 weeks, BlastInvest web site  will have major upgrade. We will have more enhanced educational content in value investing. From now on we will regularly include more content in our web site so that please tuned to our web site for more information in value investing in general if you are interested.

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