Income-hungry investors are often drawn to Business Development Companies (BDC) because of their high dividend yields (many of them are currently in excess of 10%). Generally speaking, it can be a red flag when a publicly-traded investment yields in the double digits, perhaps a sign of distress. However, the BDC space may be ripe for the picking considering many of these high-yielding companies trade at a discount to their net asset values (NAV) and show signs of financial strength. In particular, we consider the merits of Prospect Capital Corporation (PSEC) a BDC with a 14% dividend yield that trades at a significant discount to its NAV, and exhibits lower volatility and an attractive entry-point for income-hungry investors.
Why is Prospect’s Dividend Yield so High?
For starters, it’s a Regulated Investment Company (RIC) and a BDC. This means Prospect pays little to no corporate income tax as long as it pays out at least 90% of its income as dividends (BDCs were created by Congress in 1980 to help grow small businesses). Whereas many other publicly-traded companies retain a large portion of their earnings to fund future growth. For this reason, BDC’s like Prospect have relatively large dividend payments.
Next, let’s consider Net Investment Income (NII). NII is one of the most important factors in evaluating a BDC because it measures income received from investments minus expenses related to those investments. It’s basically a measure of a BDC’s ability to maintain its dividend. In the case of Prospect, its most recent quarterly net investment income was $0.28 per share and its dividend payments per quarter are $0.25 per share. This is a good thing because it means Prospect’s NII covers its dividend payments. (Note: Prospect pays dividends monthly in the amount of $0.083 per share). As another sign of strength, Prospect’s total NII has been growing. The following chart shows Prospect’s total NII and NII per share.
Another reason why Prospect’s dividend yield is so high is because its share price has fallen (mathematically as price falls, yield increases). The following chart shows Prospect’s historical dividend yield.
And for reference, this table contains a variety of additional information on Prospect as well as some of its closest peers.
Why has Prospect’s Price Fallen?
As the above table shows, Prospect has delivered a negative return over the last 1-, 2- and 3-year periods, and has not performed that great relative to the S&P 500. Keep in mind these are total returns (dividends plus price appreciation), so even after considering Prospect’s big dividend payments, it has still performed poorly.
