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These small business lenders are publicly traded and offer yields ranging from 10.5% to 13%.
We’re watching you.
I’ll be talking about three stocks in this space. First, why These companies exist.
When small businesses need capital, they don’t typically call a bank, but increasingly turn to a handful of other firms for help, such as private equity. These unique companies are: Double-digit yields And it often trades below its value. Not bad considering it offers a dividend of up to 13%!
My favorite way to raise big bucks from small businesses
In the past, when small businesses wanted capital to grow, their only source of funding was a bank. The problem is, small businesses are risky investments. Today, most banks are too risk averse to provide growth capital.
But small businesses often need cash to grow, and while some of that void is being filled by private lenders, that doesn’t help private investors. Private credit, like private equity, requires a virtual suitcase full of cash to get in, which makes it far too illiquid for our liking.
Enter Business Development Company (BDC), the stock in which we are interested.
BDCs offer a variety of financing solutions to private small businesses. They are similar to private equity, but trade on a public exchange and allow you to invest from as little as $10 or $20 per share.
Most importantly, there’s the dividend opportunity. BDCs share characteristics with real estate investment trusts (REITs): both were created by Congress; both are intended to stimulate investment in specific assets; and both are required to pay out at least 90% of their taxable income to shareholders in the form of dividends.
BDCs are more attractive because they offer higher dividends — in fact, the three-pack we’re talking about today offers roughly four times the dividend of a typical high-yield fund.
Prospect Capital: Dividend yield 13.0%
First Prospect Capital (PSEC)This is emblematic of the discount that can occur in the BDC space. Currently, the stock is trading at a staggering 62% of its NAV. In other words, the stock is priced at less than two-thirds of what it probably should be.
But should we expect anything more from one of Wall Street’s most hated stocks?
Prospect Capital is one of the blue-chip names in the BDC industry, at least by market cap ($2.3 billion). The firm’s portfolio includes 122 investments across 36 industries, the majority of which (81%) are first lien, secured or collateralized underlying debt. The majority of the firm’s business is middle-market lending to companies with up to $150 million in EBITDA, but it also participates in real estate (usually multifamily) and subordinated structured debt.
It’s hard to resist PSEC, given its many credentials: It’s highly diversified, its portfolio has a low accrued interest rate (just 0.4%), it pays dividends monthly, and its dividends have been well covered by around 85%-90% of its net investment income (NII) for some time now.
problem?
Prospect Capital has had a terrible track record with several dividend cuts and underperforming relative to better-managed peers. That’s why PSEC’s large discount to NAV is so misleading. This is not a surprise offering. The stock has been trading at a significant discount for the past decade. Year.
As I said the other day, investors should be cautious when betting on PSEC, as a string of optimistic reports like the past few quarters could shake off many of the bears, but the burden rests entirely on PSEC’s shoulders to prove a more durable turnaround in fortunes.
Barings BDC: Dividend yield 10.5%
Not as cheap, but certainly more promising: Barings BDC (BBDC)—An upbeat reform story in the BDC field.
Until August 2018, Barings was actually Triangle Capital, a BDC for small and mid-market businesses. The firm had repeatedly written off bad investments and cut its dividend. Eventually, the firm not only rebranded, but also brought on a new outside adviser, global financial services firm Barings, and began overhauling its BBDC portfolio.
Currently, Barings makes senior secured private debt investments primarily in “established” middle market companies across a variety of industries. It currently boasts 337 portfolio companies across a range of industries. Two-thirds of its investments are first lien loans, but the firm also makes second lien, mezzanine, equity, structured and joint venture loans.
BBDC shares are currently trading at 14% below their net asset value, a surprisingly low valuation given how Barings has outperformed its BDC peers over the past year.
There’s little to criticize: Barings runs a high-quality portfolio with low accrued interest and has paid dividends effortlessly for years.
Blue Owl Capital III: Dividend yield 9.4%
Blue Owl Capital III (OBDE)It is owned by an alternative investment manager. Blue Owl Capital (OWL)is one of the newest BDCs available to us, having come into existence in 2020 and listed on the stock market in January 2024.
OBDE invests primarily in senior secured debt (89% at fair value) but also participates in transactions involving unsecured debt, common equity and preferred equity. Substantially all of its investments are floating rate.
The current portfolio spans 190 companies across dozens of industries.
Despite its lack of proven track record, there are several reasons to continue to pay attention to OBDE.
Credit quality is excellent, boasting the lowest accrued interest balance to fair value (0.3%) of the three BDCs mentioned here. Despite its short trading life, OBDE’s stock is already beginning to enter bargain territory at a modest 4% discount to NAV. OBDE also has access to the deep bench of investment professionals at private credit powerhouse Blue Owl.
The dividend picture is also surprisingly concrete, at least in the short term. Blue Owl currently pays a 35-cent quarterly dividend, but has also declared five 6-cent special dividends extended through 2025. That’s a lot more certainty than you’d typically get with a special dividend.
However, there are some potential downsides to be aware of. First, OBDE charged a management fee of just 50 basis points when it was private, but after going public, this jumped to 1.5 percentage points, plus incentive fees. As a result, expenses jumped from $35.1 million to $64.7 million in the most recent quarter. OBDE also has three lockup expirations on July 23, October 21, and January 24 (2025), which could create selling pressure.
Brett Owens is Contrarian outlookFor even more amazing income ideas, get your free copy of his latest special report. Early Retirement Portfolio: Huge Dividends Every Month, Forever.
Disclosure: None
