What does Paris Hilton have in common with Andrew Carnegie,
J.P. Morgan, Carl Icahn, T. Boone Pickens and Henry Kravis, along
with a host of other ultra-wealthy people?
I am not talking about anything as obvious as havinglots
ofmoney . The core concept here is a never-changing rule ofwealth
in acapitalistic society: Nearly every vast fortune was built
uponinvesting in businesses.
Businesses are the cornerstone ofcapitalism , andprivate
equity anddebt is the fuel that transforms them into
society-sustaining enterprises. Since the Industrial
Revolution,wealthy investors have been directly involved in
providingequity , leadership and knowledge to growing companies.
These growing entities, in turn, enrich their risk-taking, life
providers, beyond belief in many cases.
This rarefied world of directly helping companies thrive is no
longer just reserved for the wealthy. Today, anyone with a
brokerage account can get involved in the business of funding a
business. One of the easiest ways to do this is to invest in
business development companies (BDCs).
My colleague Amy Calistri talks about dividend-paying dynamos
like these in her
advisory. BDCs lendcapital to established small or midsize
companies to assist their growth.
In fact, by investing directly in companies, BDCs have
advantages that even the world's wealthiest families would have a
hard time attaining. The primary advantage available to the small
investor in BDCs -- other than access to a variety of vetted and
proven companies -- isliquidity .
When wealthy investors and institutions invest directly in
private companies, there is generally a lockup offunds . This
lockup means the invested dollars are unavailable for a period of
time, which can sometimes be years. In contrast,shares of BDCs
can be bought and sold with zero lockup of capital. This is a
huge positive, particularly in a volatileeconomy .
Other advantages include consistently highdividend
payouts,diversification across a wide swath of sectors,
expertguidance , no corporateincome tax , and the potential
toprofit despite rising interest rates. Let me explain the
advantages interms oftaxes and rising rates.
In the eyes of the InternalRevenue Service, BDCs are pass-through
entities, meaning they don't pay corporate income taxes. Instead
of directly paying tax, BDCs must pay out a minimum of 90% of
theirnet income to shareholders, generally through dividends. In
other words, shareholders are taxed on the dividends rather than
the company being taxed.
Rising Interest Rates:
This can create headwinds for nearly everyinvestment . However,
BDCs can be different. If the majority of aBDC 's funds are in
floating-rateinvestments and it's borrowing money at a fixed
rate, the BDC can charge higher rates as rates increase, but the
rates locked in by the BDC remain the same. This can result in
the BDC increasing itsearnings in an environment of rising
My favorite BDC is
Fifth Street Finance (Nasdaq: FSC)
, which fits all the points made above and has been in business
for 15 years.
Fifth Street Finance calls itself an alternativelender that
provides capital to proven small to midsize companies alongside
world-class private equity companies. Here's how it works: A
private equity firm finds a company it wants to purchase, with
the goal of unlocking the untapped potential or other value
inherent within the targeted company and selling the company at a
profit. The private equity firm provides the equity to purchase
the company, and Fifth Street steps in by providing the needed
debt. Fifth Street's profits come from interest and capitalgains
Fifth Street is widely diversified across various sectors such
as health care, technology, defense and energy, among others. It
pays a monthly dividend of about 10 cents per share, which works
out to about a 12%yield . As of late March, 74% of Fifth Street's
debt investments are in floating-rate securities. As I explained,
this stands to benefit the company should interest rates continue
What closed the deal for me on Fifth Street is the recent
buying byinsiders and institutional investors. On June 19, Fifth
StreetCEO Leonard Tannenbaum added 20,000 shares to his
portfolio. In addition, a variety of other company officers have
recently increased their holdings -- and there's no stronger
endorsement thaninsider buying. In addition,hedge fund manager
David Einhorn of Greenlight Capital recently purchased almost 2
million shares, and evenanalysts at
JPMorgan Chase (
say the dividend is "secure."
Technically, I like thisstock as a momentum play. Buying now
after the breakout makes technical sense.
Risks to Consider:
Fifth Street Finance does its best to mitigate risk through
diversification and investing alongside top-tier private equity
companies, but losses are always a possibility. In addition, be
aware of the risks of overleveraging and being locked
intoilliquid investments. Always use stops and position size
properly when investing.
Action to Take -->
Adding Fifth Street Finance to your portfolio of
high-dividendstocks is an ideal way to diversify and add another
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