In 2011, the large health care and pharmaceutical company
Johnson & Johnson (NYSE:
generated $13.9 billion in
free cash flow
and maintained its "AAA"
The drug maker
had more than $29 billion of cash and short-term investments on its
as of October 2011.
The tech giant
had roughly $30 billion of cash and short-term investments on its
balance sheet as of November 2011. In October 2011, computer
was sitting on more than $13 billion of cash on its books.
Do I want to invest in these cash-rich companies?
These large and mature bellwethers have to work hard to provide
enough growth each year to budge their bottom lines. That's one
reason they buy so many young, small companies that are at the
beginning of their growth-spurts.
For instance, in the past few years, Johnson & Johnson bought a
number of small, fast-growing companies, such as Peninsula
Pharmaceuticals, Tibotec-Virco NV and Acclarent.
Meanwhile, Pfizer scooped up BioRexis Pharmaceutical Corp., FodRX
Pharmaceuticals and Excaliard Pharmaceuticals. Oracle acquired
Ksplice, Eneca Technologies and Sleepycat Software. And Dell picked
up Ocarina Networks, Boomi and Force10 Networks.
All of this leads me to ask: Why should I buy slower-growing
mega-companies if I can buy what they are buying?
There's a hitch of course. All of the small companies I listed
above were privately-held companies -- not publicly-traded on a
stock exchange. But there is a workaround.
I may not be able to directly buy into small, privately-held
companies -- but I can invest in a company that does.
Business-development companies (BDCs) loan money to private
companies. In return, BDCs get back interest and -- in many cases
-- an equity stake in the companies they loan to. If one of the
companies in its portfolio is acquired or goes public, then the
gets a piece of the action. By law, BDCs must distribute 90% of
to shareholders. As a result, BDC's have very rich
There are a number of reasons I like BDCs right now:
1. The hunt for
The Federal Reserve intends to keep its interest rates near zero,
potentially through 2014. This policy has resulted in record low
interest rates on
. Investors dependent on income aren't finding much to love about a
five-year Treasury yield of 0.7%. As a result, income investors are
scrambling for better-yielding securities, increasing the demand
for real-estate investment trusts (REITs) and BDCs.
In 2011, there were 10,241 merger and acquisition deals in
the United States, worth a total of $1.03 trillion, up 15% from
2010. More than $219 billion of activity was generated by
technology-related mergers, an increase of 17% compared with 2010.
Companies still have a lot of cash on the balance sheet. Global
demand for goods and services may continue to be slow in 2012. And
buying growth through acquisition is likely to continue to be the
best course of action for large multinational companies this year.
3. IPOs set to rebound
By the middle of 2011, it was looking to be a strong year for
initial public offerings. But when European debt worries flared in
conditions became too risky for most companies to go public. As a
result, there is a bit of a
of companies poised to go public in 2012.
Most companies will likely wait, however, until Facebook goes
public this year. Once that happens, I think a dam of smaller IPOs
will be ready to break.
4. Weak banks and stronger domestic companies
The banking sector was one of the hardest-hit during the financial
crisis. Even though the sector has been improving, there were still
844 banks on the
Problem Bank List in the third quarter of 2011, and bank failures
remain a weekly occurrence. Banks are still struggling to
strengthen their capital and have been less willing or able to lend
new money. This means BDCs and other
firms are able to find stronger companies to loan to -- companies
that would have been able to secure conventional bank credit in the
Risks to Consider:
The vast majority of BDC holdings are small
domestically-focused companies. International growth may slow due
to Europe's debt woes, but the U.S.
is on more solid footing, having grown by 2.8% in the fourth
quarter. Also, unemployment has been on a downward trend.
Action to Take -->
There are a number of available BDCs for investors. Some invest in
a wide range of private enterprises, from small restaurant chains
to small tool and die companies. Other BDCs are more specialized.
For instance, there is one BDC,
Medallion Financial Corp (Nasdaq:
, that primarily loans money to taxicab companies. My favorite BDC
specializes in lending to private technology and biotechnology
companies. And get this: it yields about 8.5%. I like it so much in
fact, I added 700
of it to my
Stock of the Month
portfolio in February.
Material costs have been high and volatile, causing problems for
manufacturers. By contrast, many tech and biotech companies have
very little exposure to commodities or industrial materials,
resulting in more stable and predictable
Overall, I think this could be a huge year for tiny tech companies.
BDCs that lend money to these small enterprises may be the best way
for investors to profit. And I think my February
Stock of the Month
is the best way for investors to tap into this
As I said, I think BDCs in general are a goodoption for investors
seeking income and growth in a "sweet spot" of the market right
now. But out of fairness to my
Stock of the Month
subscribers, I can't reveal the name of the stock I purchased for
my portfolio. To learn the name of the stock, as well as more about
simply follow this link
-- Amy Calistri
Amy Calistri does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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