Updated May 28, 2021 by Bob Ciura
Business Development Companies – BDCs for short – enable investors to generate income with the potential for robust total returns while minimizing the amount of tax paid at the company level.
Despite these advantages, business development companies are generally avoided by investors. This may be due to the tax implications of their distributions for their shareholders. But even with the added headache of tax time, BDCs can be worthwhile for high-income investors.
Prospect Capital Corporation (PSEC) is one of the more attractive business development companies in the market today.
Prospect actually pays monthly dividends and offers its shareholders a stable and predictable passive income stream that is very attractive to high income investors.
There are currently only 54 monthly dividend stocks. You can download our full Excel spreadsheet of all monthly dividend stocks (along with metrics like dividend yield and payout ratio) by clicking the link below:
Prospect Capital has a hugely high dividend yield of 8.5% six times the average S&P 500 inventory. Here is our full list of stocks with a 5% + dividend yield.
Prospect’s high dividend yield and monthly dividend payments are two of the reasons the company deserves further investigation. This article explains in detail Prospect Capital Corporation’s investment prospects.
Prospect Capital Corporation is a business development company founded in 2004. Prospect Capital is one of the largest business development companies, currently managing over $ 6 billion in assets.
Details on Prospect Capital’s business model can be found below.
Source: Investor Presentation
Prospect Capital is a leading provider of private equity and private debt financing for medium-sized companies, broadly defined as companies with 100 to 2,000 employees.
Mid-market business is beneficial to Prospect Capital due to the lack of competition from larger, more established lenders.
Medium-sized businesses are generally too small to be customers of commercial banks, but too large to be served by the small business representatives of retail banks. The “sweet spot” between these two services is Prospect Capital’s division. This lack of competition in the sector has allowed Prospect Capital to fund some really attractive deals.
The company’s current portfolio return is 9.4%, down from 12% in recent years. Lower rates around the world have lowered returns in a wide variety of asset classes, so this is to be expected.
Investors should note that Prospect Capital is highly exposed to volatile interest rates. This is because the company’s liabilities are almost entirely fixed rate while its investments are almost entirely floating rate instruments. This means that the interest expense is largely fixed, while the interest income rises and falls according to the applicable interest rates.
As interest rates rise, so will the income from prospects’ floating rate assets. At the same time, Prospect’s interest expense remains essentially constant as most of its debt is fixed income. The opposite is true, of course, since falling interest rates generally mean falling interest income.
This makes Prospect Capital a great hedge of the portfolio against interest rate sensitive securities like REITs and utilities, but underperforms in times of very low interest rates.
Prospect Capital’s flexible origination mix is also important from an investor’s point of view, as the variety of instruments used to generate income helps to find the best opportunities.
The company has nine different ways to invest with target companies, including various types of debt and equity. They all have different levels of risk and returns.
Prospect Capital’s willingness to search for the best instruments – and to have the scale for them – is a huge advantage over other mid-sized BDCs. The company’s investment strategy is central to long-term growth.
Prospect Capital’s growth prospects are largely based on the company’s ability to:
- Raise new capital through debt or stock offers
- Invest this new capital in business origins with an internal rate of return greater than the cost of capital included in step 1
The most important part of this process is Prospect’s ability to source new deals that offer reasonable risk-adjusted returns.
Fortunately for the company (and its investors), there is no shortage of new deals for Prospect to consider. The company has thousands of business opportunities every year that allow them to be very selective in their investment decisions.
Prospect reported third-quarter earnings on May 10, 2021, with results in both countries better than expected above and below Lines. Net investment income was $ 0.19 per share, while expectations were $ 0.17 per share. This was flat compared to the same quarter of the previous year.
The net asset value at the end of the March quarter was $ 9.38 $ 8.96 in the December quarter. The share of interest in total investment income was 87.5% in the third quarter 89.8% per year– –before period. Total investment income was $ 160 million compared to $ 155 million in the state year– –before period. The company has also completed $ 67 million in originations in the June quarter to date with repayments of $ 85 million.
The company focuses on disciplined underwriting so as not to take undue risk on new deals. In addition, it is ready to pass when the prudent course of action and exit when the time is right.
Prospect Capital’s dividend is the obvious reason investors would choose to own the stock. Hence, it is important that the dividend be as safe as possible.
As BDC, Prospect Capital has no choice but to distribute essentially all of its taxable income to shareholders. For this reason, the payout ratio will always be very high.
For the quarter ended March 31, Prospect Capital posted net investment income of $ 0.19 per share, well enough to cover the quarterly dividend of $ 0.18 per share.
In other words, the dividend will actually be covered by net investment income at this point, which means that the payout should be reasonably certain if the current economic downturn does not have a significant impact.
The company has now announced cumulative distributions to shareholders of more than $ 18.80.
Source: Investor Presentation
The draw for Prospect Capital clearly resides in its ability to generate cash for return to shareholders, and over time it has done well.
The dividend appears safe for now, but investors should continually monitor the company’s net investment income for signs of problems that could potentially lead to further cuts.
Prospect Capital’s high dividend yield of 8.5% and monthly payouts are two of the main reasons an investor might be interested in this stock.
A closer look reveals that this BDC has a high-profile leadership team and has positioned itself to thrive in most environments, although historically low interest rates are certainly negative, at least in the short term.
The dividend appears to be sustainable for now, which means Prospect is worth a look for those investors seeking a high ongoing income that can bear the various risks of BDC ownership.
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