NEW YORK (CNN/Money) -
While a conversation with the words "company" and "crime" is sure to raise the hackles of any executive, some U.S. firms are finding that crime does pay.
Attracted by an expanding prison population and an overcrowded penal system, investors have sent shares of Corrections Corp. of America and Geo Group soaring over the last year. Both stocks now trade at or near multi-year highs.
"The prison population really never stops growing," said Irving Lingo, chief financial officer with Corrections Corp. "Even if the growth rate slows, the real issue is that inmates are coming into systems that are already overcrowded."
Throughout the last decade, the U.S. prison population has grown by 3.6 percent annually to 2.2 million people -- or one in every 143 residents -- at the end of 2002, according to the Bureau of Justice Statistics.
That may be a scary statistic if you're a student of sociology, but it points to a nice "customer base" if you're Corrections Corp. or Geo Group.
Here today, here tomorrow
The U.S. prison population began to balloon in the early to mid 1980s due to a series of strict sentencing guidelines, including the controversial "three strikes" rule for repeat offenders.
The expansion rate started to cool as "there are only so many people willing to commit crimes," explained Andrew May, analyst with Jefferies & Co. However, the recent surge in detention of immigration offenders picked it up again.
“ Prisons are dangerous places and people can get hurt, there's no doubt about it. ”
Chief Financial Officer, Correction Corp. of America
Immigration offenders were the second fastest growing prison population in the federal system, responsible for 21 percent of the growth in 2002, according to the BJS. Drug offenders were first, accounting for 61 percent of the growth.
And those coming into the prisons have pushed the systems well over capacity.
State prisons were running at 1-to-16 percent overcapacity in 2002 and the federal system was operating at 33 percent overcapacity at the end of 2002, the latest statistics available, according to the BJS.
"With budget deficits, there just aren't a lot of beds coming into the system," said CCA's Lingo. "And when they are needed, we can build them and operate them for less than the states and government."
The notion that prison companies can build and operate for less has led to some concerns that the firms may cut corners to achieve savings.
Called inmates for a reason
In 1994, a riot broke out in an INS detention center in Elizabeth, N.J., which was managed by Esmor Corrections, now known as Correctional Services Corp (CSCQ: Research, Estimates).
Following the riot, shares of Esmor dropped to $7 from $20, losing 65 percent of its value, according to a report published by the Harvard Law Review.
"Prisons are dangerous places and people can get hurt, there's no doubt about it," said Correction Corp.'s Lingo.
He also stressed that the Nashville, Tenn.-based company has never lost a contract, which typically spans three to five years, because of a disturbance at a facility. A spokesman for Geo Group declined to comment, citing a quiet period before the company releases its quarterly results May 6.
The Harvard report acknowledged the concern that for-profit companies may cover up accidents to avoid a drop in stock price.
However, it added that it's more likely for-profit companies "are more concerned with keeping their stock prices high over the long term by insisting on sound management and that guards and wardens can be encouraged to act responsibly through stock ownership in the company."
Of prisoners and investors
Investors have taken note of the factors working in favor of the for-profit prison industry, with shares of Corrections Corp. (CXW: Research, Estimates) up about 75 percent to $36.25 as of midday Friday and Geo Group (GGI: Research, Estimates) shares up about 125 percent to $26.31 over the last year.
"These are good growth stocks and we think the earnings are going to continue to keep growing," said Don Hodges, president of Hodges Capital Management, which owned 60,000 shares of Corrections Corp. and 65,000 shares of Geo Group at the end of last week.
It also should be noted that the stocks trade on low volume, meaning that it would only take a few big trades to move the stock in either direction.
But the recent run in Corrections Corp. has given some watching the stock pause, as the price-to-earnings ratio rose to 24, above the P/E of 17 for the S&P 500.
Jefferies' May rates the stock a "hold" on valuation concerns, while he rates Geo Group as a "buy." Geo Group has a P/E of 16, below that of the S&P 500.
But if you're looking at longer-term growth, analysts expect CCA to grow by 19 per year over the next five years, while they see Geo Group growing at a slower 10 percent per year, according to research firm First Call.
This gives CCA a PEG ratio, or price-to-earnings divided by growth, of 1.3, below the 1.64 for Geo Group and the S&P 500.
Hodges said he'll hold onto the stocks despite their recent runs.
"As long as the industry continues to improve, which we think it will, these companies will be thought of as hotel companies," he added. "Because that's really what they do."
--Jefferies' May does not own shares of either stock, but his firm does have a banking relationship with CCA.