While we spend a lot of time at StreetAuthority researching
large, well-established companies, the most robust growth
opportunities are often being pursued by young and unknown
From health care to energy to retail, new businesses emerge
each year, with each hoping to eventually become an industry
dominator. These firms have also historically produced the bulk
of new jobs in the United States, offsetting the downsizing and
offshoring moves by larger companies.
Trouble is, a lot of the best small companies are still
private, and there's no way to invest in them -- unless you take
a stake in a business development company (
Indeed, BDCs are among our favorite investments, and we've
been tracking the industry's key players as they've gone on to
deliver stellar shareholder gains. Even in the face of rising
interest rates, which have diminished the appeal of yield plays
like these, they've still largely kept pace with the S&P 500
What is most remarkable about these BDCs are their
still-robust dividend yields, despite solid share piece gains in
the past few years. (Note that
American Capital (Nasdaq: ACAS)
will shift from buybacks to dividends once shares move above book
value, and though
Capital Southwest (Nasdaq: CSWC)
eschews a fixed dividend, it did pay out more than $5 a share in
dividends in 2012, on an ad hoc basis.)
Frankly, with this group gaining 54% since the start of 2012,
investors should not be focusing on further upside from here.
Indeed, rising interest rates might keep these income-oriented
investments from moving much higher in coming quarters.
But those yields remain at impressive levels, and explain why
you need to stay focused on this group. To be sure, rising rates
have a pair of offsetting implications for them. On the one hand,
it raises their cost of capital, as they are no longer able to
borrow at rock-bottom rates and lend at very wide
On the flip side, rising rates will likely come from a
steadily strengthening U.S. economy, which reduces the default
risk among portfolio holdings, and also stirs greater business
activity, opening the door for a fresh round of investment
opportunities for these BDCs.
Simply focusing on the BDCs with the strongest yields isn't
always the right way to approach this group. The fact that
KCAP Financial (Nasdaq: KCAP)
Fifth Street Finance (
Medley Financial (
BlackRock Kelso (Nasdaq: BKCC)
sport yields above 10% means that investors suspect that the
dividend either may get reduced, or at least not grow very
The key is to focus on BDCs that appear positioned for solid
dividend growth. These firms continually raise fresh capital by
selling fresh stock, and if they don't redeploy the proceeds in a
way that boosts profits -- on a per-share basis -- then they are
not really growth vehicles.
Though many of these BDCs are expected to boost profits at a
double-digit pace, a rising share count means that only four of
them will do so -- on a per-share basis. It's notable that only
KCAP Financial sports a double-digit yield and is expected to
boost earnings per share (
) at a double-digit pace in 2014 (which is a good predictor for
dividend growth as well).
Investing in BDCs also requires a fair bit of qualitative
analysis to identify firms with the strongest management teams.
In this instance, I'll defer to my colleague Andy Obermueller,
editor of our
advisory, who is StreetAuthority's resident expert in this niche.
Andy recommends three BDCs, including:
Main Street Capital (Nasdaq: MAIN)
: "The company gets its edge by focusing on simple, traditional
businesses that generate strong cash flows -- not risky
Triangle Capital (Nasdaq: TCAP)
: Triangle "looks for opportunities with businesses that have
experienced management teams, a strong competitive position, a
varied customer base (to better weather economic downturns) and
significant invested capital."
Fifth Street Finance (
: This BDC "sets itself apart by investing smaller sums in
mostly small and mid-size companies. This strategy can be
riskier than investing in a bigger company with room for
growth, but the reward is greater."
Risks to Consider:
As these BDCs grow, they are starting to step on one
another's toes in terms of investment opportunities, and that
rising competition may hinder returns as they must pay higher
Action To Take -->
These BDCs are no longer a well-kept secret, as they were a few
years ago. But their still-impressive yields stand out in a world
where most fixed-income opportunities offer relatively low
© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.