Some of my favorite companies to follow are those that not only lead, but dominate their field. These types of businesses are interesting because they have positive catalysts such as pricing power and cost efficiencies working for them, but disadvantages such as difficulty in growing sales. Intuit (NASDAQ:INTU) is one of these companies, and is the clear leader in do-it-yourself tax preparation software (TurboTax), as well as small business software (QuickBooks). Can you tell me, off the top of your head, who is the number two in tax-prep software? Small business accounting software? Me either.
First the good...
Intuit derives about 45% of its revenue from TurboTax, 40% from its small business software products, and the other 15% from products that serve financial services and international clients.
In my opinion, the bright spot in terms of future growth potential is the small business software. During periods of economic recovery and growth, the number of new small businesses skyrockets, as well as the need for accounting and payroll software. As of the last available data, QuickBooks has a market share of well over 90% in this field. The company also has a lot of potential to expand its cloud-based and software-as-a-service small business offerings, which is the direction the market is heading and is potentially a very lucrative way to sell software.
Another area of growth potential is the "other" 15% that I referred to earlier. The company has been a leader in software for do-it-yourself for some time, and has recently begun to expand its focus on offering solutions to professionals such as accountants, financial institutions, and health care providers.
Tax software challenges and how Intuit will prevail
One of the challenges in the coming years will involve the tax software business and how to produce growth. For years Intuit's revenues grew tremendously, as more and more taxpayers transitioned to online filing of their tax returns, and revenues have almost tripled in the last decade as a result. However, the latest available data from the U.S. Treasury shows that more than 80% of U.S. taxpayers now file their returns online, and that the growth rate of this percentage is slowing down, meaning that any revenue growth will need to come some other way.
On a positive note, there has been somewhat of a transition away from retail-based tax services such as H&R Block (NYSE:HRB), which provides significant opportunity for TurboTax to capture additional market share. H&R Block has claimed that about 60% of taxpayers hire someone to help with their returns – either an accountant or a retail tax-prep company. The company has a dominant market share in the "assisted tax return" segment, and dominates the space, processing about one-sixth of all tax returns filed in the U.S--about 25.6 million returns. To further emphasize H&R Block's absolute dominance in the space, consider that they assist with over 10 times the amount of returns as their nearest competitor.
One way that Intuit is trying to improve their TurboTax franchise is by making the online experience more personal for its users, and allowing them to plan for taxes in the future by analyzing their life events, such as marriage. The company hopes that this will lead to greater customer retention, and hopes to optimize the experience to try to lure away some of the tax professionals' customers.
Threats and competition
One threat that needs to be taken seriously is that retail tax services like H&R Block could start taking more of the market share by offering some type of incentive. I don't see this happening anytime soon, the primary reason being the considerably higher cost of retail tax preparation (about 4 times that of using software)--but it is certainly something to keep an eye on.
On the small business software side, there are few other players that could theoretically steal some customers from Intuit. While programs like Peachtree and AccountEdge are gaining some traction and getting good reviews, they are not much of a threat at this point. What Intuit should be worried about is a company like Microsoft developing a product that competes with its own. A lot of small-business owners (myself included) who have simpler accounting needs already use Excel to crunch the numbers, and it isn't inconceivable to add some QuickBooks-like capabilities to the program. In fact, you may remember a program that was discontinued in 2009 called Microsoft Money, which was structured as a personal finance product and had many features that would be transferable to a business accounting program.
Could you imagine what a game-changer it would be for Intuit if the next version of Office Small Business featured a QuickBooks-like program? While I don't view this as likely to happen, there is always a looming threat from one of the big software companies.
Although it leads its two major markets, I believe that Intuit still has plenty of room to grow. It is also pretty fairly valued at just 17.6 times forward earnings, which are expected to grow by a little over 10% annually over the next few years. At the current share price, Intuit would make a pretty low-risk/high reward potential addition to your tech holdings.