Investors love “sexy” investments.
The private prison industry might not be “sexy,” some would argue it’s hated, but investors should pay attention.
Overcrowding is a huge problem that the prison system hasn't been able to keep up with. On a federal level, prisons operate at 136% capacity while some states report even higher figures – California operates at 145%.
This is due to a drastic increase in people in jail. In the United States, there are approximately two million incarcerated citizens. In 1972, the prison population was around 300,000 -- a staggering 567% increase in 42 years. And many facilities are run down, over 100 years old and requiring major renovations.
Just ten years ago, there were only five private prisons in operation in the United States and now there are well over 100. Still, private prisons account for just 10% of a $74 billion market, allowing plenty of space for growth.
The GEO Group, Inc. (NYSE: GEO) is the largest private prison provider in the world with 98 facilities throughout the United States, Britain, Australia and South Africa. It trades as a real estate investment trust (REIT), and engages in the design, upkeep and management of correctional facilities.
The structure of GEO as a REIT means that the company must distribute at least 90% of its income to shareholders, resulting in larger-than-average dividend yields. At 6.1%, the stock offers a yield more than 2.5 times greater than the 10-year yield on treasuries.
The stock climbed 22% year-to-date and recently broke a 52-week high. The company beat earnings for the last three quarters by an average of 20% -- this kind of momentum suggests a strong outlook for the stock.
The publicly traded private prison industry is virtually a duopoly between GEO and Corrections Corporation of America (NYSE: CXW). While the latter is likely to take advantage of prison growth demand, it lags its smaller competitor on the fundamentals.
Its 5.7% dividend yield is smaller than GEO’s. CXW expects 12% earnings per share growth, compared to GEO’s 15%. In addition, it looks as if Corrections Corp. is slowing down given its 18.8% growth over the past five years, while GEO is on the way up with the past five years averaging 6.6%. And an important edge is GEO’s international exposure.
Risks to Consider: The prison industry is subject to strong government regulation and controversies which could hurt shareholders. In addition, the industry is reliant on arrests by law enforcement. A drop in arrest rates directly correlate with a drop in occupancy rates.
Action to take--> GEO's stock has risen sharply following the company's latest earnings report and appears somewhat overbought based on its relative strength index of 68 -- a measure of a stocks momentum. Investors should wait for a pullback before purchasing shares. Based on its long term EPS growth rate and 6% dividend yield, the stock looks fairly valued at $45 – a 20% discount from current price levels.