In a newspaper column in February 2012, I featured a relatively unknown type of dividend paying stock called Business Development Companies (BDCS).
In that column, I described a portfolio of five BDCs paying expected dividend yields ranging from 6.9% to 11.6%.
Anyone who bought those five BDCs the day after that column was published and sold one-year later would have averaged a 19% return (dividends plus share price appreciation) compared to 13% for the S&P 500.
Given those numbers, it’s worth taking another look at BDCs. First some background and then I’ll give you today’s list.
Congress created the Business Development Company category a number of years ago to encourage the flow of capital to firms that are too large to borrow from banks, but too small to list on the stock market. These are typically firms with annual revenues from $10 million to $300 million. BDCs make mostly short-term, unsecured loans in the $2 million to $50 million range to such firms. Also, BDCs often take ownership positions (equity interest) in their client companies.
Here’s what makes BDCs so interesting to us. Congress decreed that BDCs would not be required to pay federal corporate income taxes if they paid out at least 90% of taxable income as dividends to shareholders.
To qualify for that tax break, BDCs must also invest at least 70% of assets in private or thinly traded public corporations and offer managerial assistance to their client companies.
On the downside, because they don’t pay corporate taxes, dividends paid by BDCs are not subject to the 15/20% maximum tax rate. Instead, BDC dividends are taxed at ordinary rates. Thus, it’s best to hold them in tax-sheltered accounts.
Fair Weather Stocks
Because they invest in relatively small companies that might not survive severe economic downturns, you should consider BDCs to be “fair weather” stocks. That is, only invest in BDCs when the U.S. economic outlook looks strong. I believe that is the case now, but don’t even think about buying BDCs if you don’t agree.
Most BDCs pay quarterly dividends, but because many income investors prefer to receive monthly payouts, last year’s portfolio included only monthly dividend payers. This year, I’m taking a different tack.
Buy High & Sell Higher
Although we’re told to “buy low and sell high,” considerable research has found that the best returns come from stocks that have already outperformed the market. In other words, “buy high and sell higher.” This is the basis of the “momentum” strategies followed by many hedge funds.
Of the 22 BDCs that I track, here are the top six in terms of the last 12-months’ price action, with the most weight given to recent moves. Unless otherwise noted, all pay dividends quarterly.
Triangle Capital (TCAP)
Makes loans in the $5 million to $25 million range to companies with revenues of $20 million to $200 million. Pays dividends equating to a 7.5% expected yield (next 12-months dividends divided by current share price).
KCAP Financial (KCAP)
Makes loans in the $1 million to $10 million range to companies with revenues of $10 million to $100 million. Also manages funds that invest in syndicated loans, high yield bonds and other credit instruments. Pays an 10.8% expected dividend yield.
Hercules Technology Growth Capital (HTGC)
Provides senior secured loans from $5 million to $50 million to venture capital-backed technology firms, in all stages of development, including start-ups. Pays 8.1% expected yield.
Pennant Park Floating Rate Capital (PFLT)
Makes mostly “floating rate” senior secured loans in the $1 million to $10 million range to companies with revenues from $30 million to $300 million. Pays monthly dividends, 7.2% yield.
Fidus Investment (FDUS)
Provides loans in the $4 million to $12 million range to companies with revenues in the $10 million to $150 million range. Pay an 8.2% yield.
Medley Capital (MCC)
Offers loans from $10 million to $50 million to companies with revenues form $30 million to $300 million. Pays an 8.9% yield.
The estimated dividend yields listed assume that each BDC will continue paying the same amount as its last declared dividend for the next 12-months. If the economy continues to strengthen, you can expect dividend hikes. Conversely, expect dividend cuts and lower share prices if the economy sours.
The BDCs listed are my picks. As always, you should do your own due diligence. The more you know about your stocks, the better your results.