More often than not, a company with a dividend yield approaching double-digits has something seriously wrong with it. Revenues might be plunging, profits may have fallen off the table, and bankruptcy rumors might even be circulating.
If that's the case, don't expect that enticing yield to last long - a dividend cut is likely coming soon.
However, there are several companies with good prospects currently offering dividend yields north of 8%. I have listed four of them below. One thing they all have in common: they are all business development companies.
Publicly Traded Private Equity
Business development companies, as the name implies, help small businesses grow by providing them with capital. This is similar in many ways to banks, venture capital and private equity firms.
BDCs borrow money at relatively low rates and lend money out at higher rates, making money on the spread between the two. The type of capital that BDCs typically provide is in the form of 'mezzanine' loans. These loans usually come with higher interest rates than your normal bank loan.
Of course, these loans are often riskier than your normal bank loan too. In the event of bankruptcy, for example, senior debt lenders (banks) get first dibs on a company's assets. Mezzanine or 'subordinated' debt lenders (BDCs) come next. Equity holders get the leftovers, if any.
A potential benefit of this financing is that it sometimes comes with the option to be converted to equity if a company takes off, providing greater upside. A bank, on the other hand, will only ever earn the stated interest on the loan, no matter how well the company does.
Most BDCs are treated as regulated investment companies (RICs) for tax purposes. Just like a REIT or MLP, RICs pay no corporate income tax on the money they distribute to investors through dividends, as long as they pay out at least 90% of their profits. This can lead to some pretty enticing dividend yields.
But BDCs usually invest in small, relatively risky companies that can be highly volatile. In the event of a prolonged recession, many of these businesses will cease to exist, and BDC's will take it on the chin.
One example is Allied Capital. The former juggernaut essentially went belly up as a result of the financial crisis, agreeing to be purchased in early 2010 at a fire-sale price. American Capital Strategies (NasdaqGS:ACAS - News), another former powerhouse, stopped paying a dividend in 2008 and narrowly avoided bankruptcy. Shares are still down about 80% for their peak in 2007.
4 Attractive BDCs
Below are four growing BDCs with attractive dividends and very reasonable valuations. They are relatively young, but three of the four endured the Great Recession without a dividend cut. The other went public in 2010.
Dividend yield: 9.4%
Forward P/E: 10.4
Triangle Capital Corp targets companies with annual revenues between $20 and $100 million with a history of generating revenues and positive cash flows, an established market position and a proven management team with a strong operating discipline. Triangle's debt investments generally have a term of 3-7 years with interest rates between 12.0% and 17.0% - much higher than a typical bank loan.
The company has steadily raised its dividend since going public in 2007 - even during the Great Recession. More dividend hikes could be on the horizon too. Following strong first quarter results, management stated that it believes it is well-positioned to continue increasing its dividend over the next several quarters.
TCAP: Triangle Capital Corporation Dividend History
Dividend yield: 9.4%
Forward P/E: 9.5
PennantPark Investment Corporation primarily invests in middle-market companies in the form of senior secured loans, mezzanine debt and equity investments. PennantPark invests in companies that are usually quite a bit larger than Triangle Capital's, with annual revenues between $50 million and $1 billion. These companies are often highly leveraged and are not usually rated by national rating agencies.
PennantPark states that 'if such companies were rated, we believe that they would typically receive a rating below investment grade (between BB and CCC under the Standard & Poor's system) from the national rating agencies.'
But these riskier investments have paid off so far. PennantPark Investment Corporation also went public in early 2007 and has been steadily increasing its dividend ever since.
PNNT: PennantPark Investment Corporation Dividend History
Dividend yield: 8.1%
Forward P/E: 11.1
Horizon Technology Finance Corporation targets development-stage companies in the technology, life science, healthcare information and services, and cleantech industries. As of March 31, no investments were on non-accrual status.
Horizon went public in October 2010 and thus doesn't have much of a track record of dividend payments. It's off to a good start so far, however, raising its payout by 50% in May.
HRZN: Horizon Technology Finance Corporation Dividend History
Dividend yield: 8.1%
Forward P/E: 13.1
Main Street Capital Corporation provides customized debt and equity financing to lower middle market companies with annual revenues between $10 and $100 million. The company's investments generally range from $3 million to $20 million. Approximately 70% of its investment portfolio is in first lien debt.
Main Street Capital went public in the fall of 2007, right before the start of the Great Recession. Nonetheless, the company has consistently paid out juicy dividends (it pays them every month) and recently upped it by 4%.
MAIN: Main Street Capital Corporation Dividend History
The Bottom Line
A stable dividend yield of 8% or more is attainable in today's market. These four business development companies, while young, all have solid track records so far. If the economy turns south for a prolonged period, however, many of their loans might not get repaid, and they could suffer.
Todd Bunton is the Growth & Income Stock Strategist for Zacks Investment Research.
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