Business development companies (BDCs) have had a rough go of it during the recent market sell-off. While the S&P 500 is down just over 2% in the past month, most BDCs are down 5% or more.
BDCs lend to, invest in, and provide managerial advice to mid-market companies, generally $20 million to $200 million in revenue. Investors are concerned that the economic torpor will limit new investment opportunities.
At the same time, the investments on the books will fail to generate sufficient income. Most BDCs are financed with a fixed-debt structure, while most of their assets are variable rate. BDCs would benefit in a rising-rate environment, which has yet to materialize.
That said, I like the BDC sell-off because it offers the opportunity to capture even higher yield. The concerns, in my opinion, are overdone. Prospect Capital Corp. (NASDAQ: PSEC) is my top BDC stock at the moment. It offers a huge 13.6% yield based on its $1.33 annual dividend. I like the annual dividend even more because it’s paid in monthly installments.
This BDC stock yields 13.6% for a number of reasons, and as you likely expect, they are not good.
Prospect’s most recent quarterly earnings left much to be desired. Prospect watchers were expecting earnings per share of $0.32, but it came in at $0.25. The earnings shortfall is a concern, but the dividend is of greater concern.
Prospect’s value begins and ends with its dividend. The earnings situation is concerning, but the dividend isn’t really support by earnings; it’s supported by net investment income (NII). On that front, NII posted at $1.19 in fiscal-year 2014. It doesn’t require a math major to realize $1.19 fails to cover $1.33. (This predicament isn’t unprecedented. Prospect failed to cover the dividend in 2011, but it remained intact.)
Dividend concerns were further amplified when Prospect failed to declare another three months’ worth of dividends at the time of its quarterly report, which it usually does.
Investors might be reading too much into the non-declaration. In a recent press release, management stated that the current quarter’s income will “substantially exceed” the dividends it pays. In addition, Prospect did declare another monthly dividend, which means monthly dividends are declared through February 2015.
Prospect’s shares are down roughly nearly 7% over the past month. I view the lower price as an opportunity to pick up yield – 13.6% – and value: The shares trade at an 8% discount to net-investment value of $10.56 per share, when they usually trade at a 5% to 10% premium.
Two Prospect insiders appear to agree with my assessment. A couple weeks ago, CEO John Barry bought 100,000 Prospect shares at an average price of $10.17 per share. Around the same time, COO Grier Eliasek bought 5,000 shares at $10.10 per share. This year alone, Prospect insiders have bought over 500,000 shares, with most of the purchases occurring during sell-offs.
The fact that insiders are keen to jump in when others jump out is useful information. Insiders sell for many reasons, but they buy for only one – to make money. I think money will be made in Prospect Capital Corp. shares – on both dividend yield and price appreciation. What’s more, you can make more money than either the CEO or the COO based on Prospect’s current market price.
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