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The GEO Group, Inc.'s (NYSE:GEO) Intrinsic Value Is Potentially 97% Above Its Share Price

Key Insights

  • The projected fair value for GEO Group is US$29.44 based on 2 Stage Free Cash Flow to Equity

  • GEO Group is estimated to be 49% undervalued based on current share price of US$14.97

  • The US$19.25 analyst price target for GEO is 35% less than our estimate of fair value

Does the June share price for The GEO Group, Inc. (NYSE:GEO) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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Check out our latest analysis for GEO Group

The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$276.7m

US$266.8m

US$262.5m

US$261.4m

US$262.5m

US$265.1m

US$268.9m

US$273.4m

US$278.7m

US$284.4m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Est @ -1.63%

Est @ -0.42%

Est @ 0.42%

Est @ 1.01%

Est @ 1.42%

Est @ 1.71%

Est @ 1.91%

Est @ 2.05%

Present Value ($, Millions) Discounted @ 8.4%

US$255

US$227

US$206

US$189

US$175

US$163

US$153

US$143

US$135

US$127

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.8b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.4%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 8.4%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$284m× (1 + 2.4%) ÷ (8.4%– 2.4%) = US$4.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.8b÷ ( 1 + 8.4%)10= US$2.2b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$3.9b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$15.0, the company appears quite undervalued at a 49% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at GEO Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 8.4%, which is based on a levered beta of 1.312. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for GEO Group

Strength

  • No major strengths identified for GEO.

Weakness

  • Earnings declined over the past year.

  • Interest payments on debt are not well covered.

  • Shareholders have been diluted in the past year.

Opportunity

  • Annual earnings are forecast to grow faster than the American market.

  • Good value based on P/E ratio and estimated fair value.

  • Significant insider buying over the past 3 months.

Threat

  • Debt is not well covered by operating cash flow.

  • Annual revenue is forecast to grow slower than the American market.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price sitting below the intrinsic value? For GEO Group, we've compiled three further aspects you should further research:

  1. Risks: We feel that you should assess the 3 warning signs for GEO Group (1 can't be ignored!) we've flagged before making an investment in the company.

  2. Future Earnings: How does GEO's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.