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Business
Development Cos For High Yields
It’s getting harder for dividend investors to find high
dividend-yield stocks. But, several stocks in one category, Business
Development Companies, are paying dividends equating to 7% to 8% yields.
Business Development Companies (BDCs) are a special type
of corporation that doesn’t pay federal income tax as long as it
distributes most of its profits to shareholders and follows certain
other rules.
The U.S. Congress created the BDC category in 1980 to
encourage the flow of private equity capital to mid-sized businesses.
To qualify for the special tax treatment, a BDC must
invest at least 70% of its assets in private or thinly traded public
corporations, and must distribute at least 90% of its taxable income to
shareholders in the form of dividends. BDCs must also make significant
managerial assistance available to their client companies.
BDCs make mostly short-term, unsecured loans in the $20 to
$50 million range to their clients. Such loans, when made to
corporations, are often termed “mezzanine” loans. BDCs often take an
ownership position (equity interest) in their client companies.
Finding BDCs
You can use AOL’s free stock screener to find BDCs. In case you hadn’t
heard, you no longer have to be an AOL member to access its features.
From AOL’s homepage (www.aol.com),
select Money & Finance,
then
Stock Screener, and finally, click on
Launch the Screener.
Use the industry drop-down menu to select “investment
firms,” and then specify a 6% to 19% dividend yield.
Dividend yield is the current annualized dividend rate
divided by the recent share price. The annualized dividend rate is
simply the last declared quarterly dividend multiplied by four. So if a
firm declared a $0.25 per share quarterly dividend, its annualized
dividend would by $1.00. Its dividend yield is 5% if it’s trading at $20
per share ($1 divided by $20).
I selected the 6% minimum to limit my search to high
dividend payers. Try lowering that figure if you want to see more
stocks. I set the maximum acceptable yield at 15% because higher yields
are unrealistic and indicate that many players expect the firm to cut
its dividends.
My screen listed 11 BDCs: Allied Capital (ticker symbol
ALD), American Capital Strategies (ACAS), Apollo Investment (AINV),
Compass Diversified Trust (CODI), Gladstone Capital (GLAD), Hercules
Technology (HTCG), MCG Capital (MCGC), NGP Capital Resource (NGPC),
Patriot Capital Funding (PCAP), Prospect Capital (PSEC), and Technology
Investment Capital (TICC).
Allied Capital, and American Capital Strategies, publicly
traded since 1984 and 1997, respectively, are the oldest, and thus, the
most seasoned of the group. The balance all came public since 2001.
Most invest in firms in a variety of industries, but
Hercules Technology and Technology Investment, as their names imply,
confine their activities to tech companies. NGP Capital Resource and
Prospect Capital focus on the energy sector, but Prospect recently said
it plans to diversify beyond the energy industry.
Analyzing BDCs
BDCs profit from the interest collected on their loans and from fees for
providing management assistance to their clients.
The capital gains that BDCs earn when they sell their
ownership positions in client firms also contribute significantly to
income. Unlike interest and fee income, which, although growing, is
relatively consistent from quarter to quarter, capital gains come in
lumps and are hard to predict.
That aspect makes BDCs difficult to analyze because in a
quarter without capital gains, it may appear that a BDC is not
generating enough income to cover its dividends. Another factor to keep
in mind is that because they must pay out most of their profits to
shareholders rather then reinvesting them, BDCs must either borrow or
sell more shares to finance growth.
Book value growth is the best way to gauge a BDC’s
performance, in terms of shareholder value. Shareholders equity is a
firm’s assets minus its liabilities, and book value is shareholders
equity expressed on a per-share basis.
You can see the book value as of the end of its most
recent quarter on many sites, however MSN Money’s Key Ratios report is
the only place I know of to view long-term trends. From MSN Money’s home
page (moneycentral.msn.com),
get a price quote, then Financial Results, then Key Ratios, and finally,
Ten Year Summary. The report shows the year-end value of a variety
of performance ratios going back 10 years, if the company has been
around that long.
Ideally, book value should be growing from year-to-year
Most BDCs trip up in that department occasionally, but the closer they
come to consistent growth, the better.
While on the Key Ratios Ten Year Summary, notice the
price/book column. The price/book ratio is how much you have to pay for
each dollar of book value.
You’ll notice that most BDCs usually trade in the $1.25 -
$1.75 range for price/book. So assuming that a BDC isn’t facing major
fundamental problems, you best bet is buying near the low end of that
range and avoiding BDCs trading near the high end.
Also, avoid BDCs expected to suffer an earnings decline
this year or in 2008. You can see analysts’ forecasts on MSN Money by
selecting Earnings Estimates (after getting a price quote).
Business Development Companies made their shareholders
happy last year. Based on Morningstar data (www.morningstar.com),
the 10 BDCs that AOL’s screen turned up that were publicly traded the
entire year averaged a 31% return (dividends plus share price
appreciation) in 2006.
However, some analysts warn that BDCs have already had
their day and are unlikely to repeat last year’s results. So do your due
diligence. Read each BDCs earnings reports and everything else you can
find. The more you know about your stocks, the better your results.
published 6/24/07 |
