Updated July 16, 2021 by Bob Ciura

As the saying goes, when something looks too good to be true, it usually is. This often applies to unusually high-yielding dividend stocks, many of which have to cut dividends in a recession.

Stellus Capital Investment Corp. (SCM), for example, has a dividend yield of almost 8%, which is very attractive at first glance. The S&P 500 Index has an average dividend yield of just 1.3%.

In addition, Stellus pays its dividend every month rather than every quarter like most companies. This helps make Stellus stand out as we currently only cover ~ 51 monthly dividend stocks.

You can download the full list of monthly dividend stocks (along with key financial metrics like dividend yields and payout ratios) by clicking the link below:

However, while high dividend stocks are very attractive in a relatively low interest rate environment, investors need to make sure that the dividend is sustainable.

Stellus has a very high payout ratio of almost 90%. As a BDC, Stellus has to essentially distribute all of its earnings so that its payout ratio will always be high. However, it is in the best interests of investors to carefully monitor the company’s earnings performance for any signs of a potential dividend cut.

This article discusses Stellus’ fundamentals in terms of supporting the dividend yield of nearly 8%.

Business overview

Stellus is a Business Development Company or BDC. It invests in small, mostly private companies, which are usually in the early stages of their growth cycles.

Stellus is a medium-sized investment company and makes equity and debt capital investments in private medium-sized companies. The company offers capital solutions for companies with 5 millionMillion to $ 50 million EBITDA and does this using a variety of instruments, most of which are debt.

Stellus offers first lien, second lien, mezzanine, Convertible bonds and investments in a diverse group of customers, usually with high returnsds in the US and Canada.

Source: Investor Presentation

In addition, it has a highly diversified investment portfolio both geographically and in terms of industry concentration. Stellus will make a variety of debt investments including first lien, second lien, varsity tranche and mezzanine financing.

Investments are made in a variety of industries including business services, industrial, healthcare, technology, energy, consumer goods and finance. Invested capital is used for a variety of purposes including acquisitions, growth investments, and more. Stellus is managed externally by Stellus Capital Management LLC, a registered investment advisor.

The company pursues a disciplined investment strategy. It closed less than 2% of the trades audited. Its relative selectivity allows the company to focus on the highest quality investments.

It also means the company has far more investment opportunities than it needs, and it improves its ability to select only the best investments. Stellus generates particularly high returns on its first lien, second lien and unsecured debt securities.

Next, let’s take a look at the company’s growth prospects.

Growth prospects

A strong catalyst for Stellus is its growing investment portfolio. Stellus has seen its investment portfolio grow rapidly over the past five years, which has enabled the company to generate higher investment returns.

However, all of this stalled in 2020 when the coronavirus pandemic plunged the U.S. economy into deep recession, negatively impacting many of Stellus’ investments.

The good news is that the company’s results seem to have stabilized. Stellus reported its first quarter results on May 6ththe, 2021, with mixed results against ExExpectations. investment Income for the quarter was $ 14 million, up from $ 15.3 million a year agobefore period and was almost entirely from interest income from portfolio investments.

Net investment income for the first quarter was $ 5.1 millionProfit of $ 6.2 million a yearbefore period. On a per share basis, NII per share declined 19% compared to the prior year quarter.

Net assets from operating activities were $ 4.9 million over the $ 43.9 million decrease per year over the same period before thath was due to massive disruptions in the financial markets due to COVID. traced back19th. This corresponded to a profit of 25 cents each Share in this year’s Q1.

Another potential catalyst for Stellus could be higher interest rates. As a primary bond investor, Stellus could benefit from higher returns on its future investments. Higher inflation in 2021 could create the conditions for interest rate hikes in 2022.

In addition, almost all of the company’s portfolio has variable interest rates. This is positive in a rising interest rate environment, but this leverage works both ways.

Dividend analysis

When it comes to dividend stocks, Stellus is not a typical choice. It has a relatively short dividend history of less than 10 years, which means it doesn’t have a long track record of persistence.

Below is a picture of the company’s sales history:

Source: Investor Presentation

Stellus currently pays a monthly dividend of $ 0.0833 per share, which equates to an annualized payout of $ 1 per share. That’s a drop of $ 0.1133 per share in 2020. The company cut its dividend last year due to the pandemic. On a positive note, Stellus paid a special dividend of $ 0.06 per share last year, but dividends still remain well below the high.

Net investment income per share is expected to be $ 1.15 per share in 2021. With the current annualized dividend of $ 1, Stellus currently has a payout ratio of 87%. This means that the current dividend distribution is sustainable, but only just barely. Keep in mind that BDCs have to distribute virtually all of their income, so Stellus’ payout ratio will always be high.

Even so, the company doesn’t have much leeway. Even a slight decline in investment income could cause the payout ratio to rise above 100%, suggesting a potentially unsustainable dividend.

It is very important that Stellus continues to increase its investments, as recent results show. Stellus is a high-risk, high-yield dividend stock. If the company’s growth stays on track, investors will get a return of ~ 8% from the dividend alone, plus any capital appreciation from a rising share price.

Even if the company holds its dividend, investors shouldn’t expect much in terms of future dividend growth. Net investment growth has been sluggish and given the high payout ratio, we don’t see any catalysts for a higher payout in the near future.

Final thoughts

Stellus could be an attractive choice given that it has a dividend yield of nearly 8% and some growth potential.

Plus, Stellus pays its dividend each month, which helps to amplify the compounding effect on reinvested dividends and make the stock more attractive to those who depend on dividends for a living.

Of course, there is no guarantee that the company’s growth plans will be successful, and with a payout ratio close to 100%, there isn’t much room for error. As a result, investors face the risk of a future dividend cut if financial results deteriorate. Only investors willing to take this risk should consider buying the stock.

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