Soon after we purchased Jackson Hewitt (JTX), offices of one of their franchisees was raided by the U.S. Justice Department; the franchisee was accused of falsifying tax returns for thousands of taxpayers. JTX stock collapsed on that news. The risk was that it was a widespread practice and JTX management was complicit with the franchisee and that the brand may have been damaged and lawsuits would follow. We thought otherwise: The management had no incentives to resort to outright spend-time-in-jail type of fraud, they had a great business on their hands; it made no sense for them to do something that stupid.
Though that incident made headlines in the localities where it took place, national media was preoccupied with more important developments at the time (i.e. Paris Hilton going to jail) and thus the JTX’s brand was unscathed. We liked JTX’s management when we purchased the stock, but we were even more impressed with their response to this incident: they hired an ex-IRS commissioner to head an independent internal investigation and clearly communicated to investors about the investigation.
As we expected the IRS did not find anything, management settled the issue with them (basically paying the IRS $1.5 million to go away). Here is an opportunity. The “bad news” (which now was not really bad) drove the stock down to about 12-13 times earnings, but JTX has a handful of growth drivers that should bring earnings growth in mid to high teens for years to come as it only has a 4% market share of a very fragmented market. Management spends every penny of free cash flow to return to shareholders (our kind of management) through a 2.6% dividend yield and stock buyback.