On June 9, shares of real estate investment trust (REIT) The GEO Group (NYSE: GEO) were higher, at one point in the day, by nearly 70%. By the end of the trading day, the gain had been pared back to "just" 28% or so. Was there some big company news driving this extreme volatility? Nope, it was just another sign of the Reddit craze that's taken over Wall Street. Here are some things to consider before you join in the mania.
What’s the real story here?
It may sound silly to say this, but before you invest in a stock, you should probably understand the company that has issued the shares you're buying. In the case of The GEO Group, it's a REIT that owns and operates prisons. REITs are a special type of corporate structure that avoids corporate-level taxes by passing virtually all of the taxable income generated on to shareholders via dividends. The big-picture goal of a REIT is to allow individual investors access to institutional property markets.
In the case of The GEO Group, that makes a lot of sense. A small individual investor might be able to afford a rental home or even a modest apartment building, but it's highly unlikely they would be able to acquire and run a prison. For years, this was a pretty solid business, with the U.S. government at various levels looking to cut costs by, effectively, outsourcing prison operations.
Things have changed materially, however, under the current administration in Washington D.C., with a Jan. 26 executive order directing the U.S. Justice Department not to renew contracts with for-profit prison operators.
In fairness, this order only impacts the Federal Bureau of Prisons and U.S. Marshals Service. However, it sets a tone for other levels of government that also make use of the services of companies like The GEO Group. There are a lot of other government agencies, at different levels, that make use of for-profit prison services, and it would be impossible to simply end all of the contracts here at one time. So The GEO Group's business isn't going away overnight, though it has already been informed that some of its contracts aren't going to be renewed. Put simply, there is still a real business here, but there are also very real long-term industry headwinds that investors now have to consider.
In addition to that, The GEO Group also has a very heavy debt load. The REIT's financial debt-to-equity ratio is nearly three times. As a comparison, some of the largest, best-known REITs, like Simon Property Group, Prologis, AvalonBay, American Tower, Federal Realty, and Realty Income, are sitting at 0.75 times or (much) lower on that metric.
This helps explain why The GEO Group, which has a junk bond rating, suspended its dividend on April 7 so it could put that cash toward debt repayments. Think that through for a second: This is a REIT that now pays no dividend -- not exactly a good sign given the entire purpose of the REIT structure is dividends. Does this sound like a company you'd want to own for the long term?
Reddit made me do it!
If you answered that last question with "no," you wouldn't be alone. In fact, given the backdrop here, a lot of investors have been selling the stock short, or selling shares they don't own in the hope of price declines so they can buy and close their position at a profit. This is a fairly advanced tactic that most small investors should probably avoid, but institutional investors do this type of thing all the time to profit from the travails of troubled companies. The so-called short interest in The GEO Group is over 30%, which is pretty high.
Folks on the Reddit message boards, however, look for exactly this type of situation and try to force what's known as a short squeeze. The goal is to quickly increase the price of a heavily shorted stock to the point where short sellers have to close their positions (by buying shares) to limit their losses. That, in turn, can lead to further stock price increases, since desperate short sellers will often buy at any price to stop the financial pain of losing position. A short squeeze is an amazing thing to watch. You can see a stock price rise by as much as 70% intraday, only to fall back to a gain of 28% by the close.
Think this through before you follow the Reddit crowd
If that's attractive to you, remember that if you bought shares of The GEO Group when they were up 70%, hoping for further gains, you would have suffered a massive loss by the end of just one trading day. You have to be on the right side of this trade, or you can get burned very badly in a very short period of time. Are you confident you'll be able to time that right?
The short-term nature of a short squeeze is the key variable here to consider against the long-term fundamentals of the company involved. If you can't watch your investments minute by minute, or even second by second, you should not get involved in the Reddit craze around The GEO Group, or any other company for that matter, because you could end up being the last one in the door and left holding the bag.
The people on Reddit message boards don't really care if you lose money. Most investors should avoid the Reddit hype, even if that means missing out on exciting trading action, and stick to owning good companies with solid prospects for long periods of time -- which is basically how Warren Buffett (and many others) made himself a very rich man.