IF THE GAME OF MONOPOLY WERE a reality show, Jail would be worth more than Boardwalk. Crime, you see, does pay if you're a sharp-eyed investor. Specifically, there's money to be made in shares of prison companies like GEO Group, Corrections Corp. of America and Cornell Co. -- despite a recent U.S. Census report intimating that the prison population is growing at 4% annually, not the widely publicized 13% forecast by the Pew Charitable Trusts in February. The census report took the wind out of the billowing sails of the jailer's stocks, and herein lies an opportunity. The Pew data, by our reckoning, are almost certainly more accurate.
Government statisticians sampled just 37 states, while Pew looked at hard data from 42 states and estimates from the other eight. By the time Census had published its report last month, the actual prison population figures reported by the states to the Justice Department for 2006 were higher than its estimates. So Pew's forecast that the number of prisoners will rise by 192,000, to close to two million by 2011, appears to hold up. The Pew report estimates that the growth in the prison population will produce a five-year cost to taxpayers of $27.5 billion.
ALTHOUGH ALL THREE PRISON COMPANIES trade at lofty price-to-earnings ratios, they look reasonable in light of the prison population's likely growth.
Corrections Corp. (ticker: CXW), for example, at its recent price around $25, was trading at about 24 times its estimated earnings for this year of $1.04 a share, well above the 20.5 of the S&P 500. The company's earnings, however, look to be growing around 20% annually, helping to justify the price. If the shares keep their current P/E, the price could jump to $30.
GEO (GEO), which was hurt Friday by the announcement that it is losing a contract in Texas, trades at 26 times estimated earnings for this year. But its CEO sees no impact on this year's earnings from the Texas decision. Indeed, net could well rise by more than 25%, to $1.36 a share, perhaps lifting the shares to $35 from the high 20s.
Cornell (CRN), whose earnings estimates were cut this year after it lost a federal contract for the incarceration of illegal immigrants at one of it's Arizona prisons, also looks pricey at first glance, trading at 30.5 times 2007 earnings estimates. But analysts say that earnings could rebound next year to $1.27 a share from an estimated 82 cents this year, sending the stock up by 40% or more. Returns like that seem almost, well, illegal.
Granted, the jailers are in a risky business. A riot or high-profile escape or a case of abuse can cost them dearly -- in the form of congressional hearings, lost federal contracts and more. But the rewards to investors can be considerable -- not only in stocks but also in bonds.
JOHN MOUSSEAU, A PORTFOLIO MANAGER at Cumberland Advisors, likes triple-A , insured bonds issued by prison authorities in Sunbelt states like Virginia, the Carolinas and Arizona. "From a demographic perspective, you look for prison bonds in growth areas of the country," he says. "Growing areas mean more crime!"
He says that Cumberland likes bonds in which a number of counties or regional jurisdictions share the cost of a prison and agree to use it exclusively for their convicted bad guys. Mousseau says that if the state helps the regional players with construction costs, that makes the bond issue even more attractive. One year ago, he bought Virginia-based Rappahannock Regional Jail Authority 4.5% due Dec. 1, 2036, that was yielding 4.60%. "They are probably worth that or a touch less today," he says.
If you have reservations about owning a stake in a harsh institution like a prison, consider this: Some of our nation's most creative CEOs now reside in prisons. That thought sure makes us feel better about this kind of investing.