The overall economy is showing signs of perking up, but banks are still paying next to nothing in terms of interest on your savings. Consequently, dividend-paying stocks are getting a hard look from investors seeking steady income.
If you’re in that camp, Business Development Corporations (BDCS) are worth a look. Many are paying dividends equating to 8% to 11% yields (annualized returns on invested capital), and some are paying even more.
A BDC is a special type of corporation, created by Congress to encourage the flow of private equity to companies that are too large to borrow from banks, but too small to list on the stock market. These are mainly companies with annual revenues in the $10 million to $75 million range.
Business Development Corporations pay high dividends because they don’t pay federal income taxes if they follow the rules.
Special Tax Treatment
To qualify for the special tax treatment, BDCs must invest at least 70% of assets in private or thinly traded public corporations, must offer managerial assistance to their client companies, and most important from our perspective, BDCs must pay out at least 90% of taxable income as dividends to shareholders.
More On BDCs
BDCs make mostly short-term, unsecured loans in the $2 million to $50 million range. Also, they frequently take ownership positions (equity interest) in their client companies. Since they must pay out most of their profits to shareholders, BDCs must raise cash to fund expansion by selling more shares or via borrowing.
BDCs went through hard times in 2008 and early 2009 when the economy tumbled. Most, however, have recovered, are financially strong, and well positioned to prosper if the economy strengthens this year, as many economists expect.
Some Pay Monthly Dividends
Many income investors prefer to receive monthly dividends, rather than the more common quarterly payouts. Of the 25 or so BDCs, here are the five that pay monthly.
Full Circle Capital (FULL)
A relatively new BDC (September 2010), Full Circle invests mainly in senior secured loans and, to a lesser extent, unsecured loans and equity securities issued by firms with annual revenues in the $3 million to $75 million range. Its loans typically range between $3 million and $10 million. Full circle pays dividends equating to an expected 11.6% yield.
Gladstone Capital (GLAD)
Offers mostly senior loans in the $3 million to $15 million range to small and medium sized businesses. Pays a 10.2% yield.
Gladstone Investment (GAIN)
Makes debt and equity investments ranging from $3 million to $20 million in small and mid-sized private businesses to facilitate acquisitions, changes in control and recapitalizations. Gladstone Investment makes riskier loans than Gladstone Capital, and may also take direct equity positions in its client companies. Pays a 7.7% yield.
Main Street Capital (MAIN)
Provides $2 million to $15 million of long-term debt and equity capital to companies with revenues in the $10 million to $100 million range to support management buyouts, recapitalizations and acquisitions. Pays a 6.9% yield.
Prospect Capital (PSEC)
Lends to and invests between $5 million and $50 million in private and micro-cap public businesses. Pays an 11.1% yield.
The estimated dividend yields that I listed assume that each BDC will continue paying the same amount over the next 12-months. If the economy continues to strengthen, they should be able to maintain, or even increase their current payouts.
Not A Slam Dunk
Dividend yields, of course, aren’t the whole story. Your total return on any stock is comprised of the dividends received plus or minus any share price changes. Thus, a share price drop could put you in the negative column despite the high dividends. In terms of total returns over the next three to six months, Main Street Capital and Prospect Capital are my top choices.
Those are just my guesses, of course. As always, you should do your own due diligence. The more you know about your stocks, the better your results.