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As a dividend investor, you want to invest in a company that accomplishes two things. One, you want to earn an attractive dividend yield. And two, you want a company that pays a dividend consistently.
Both of these qualities can be found in business development corporations (BDCs). These companies provide funds to businesses through loans and equity investments, and allow ordinary investors to grab a share of the profits too. Because of their tax structure, BDCs pay out higher dividend yields than other companies. These can be a great source of monthly income as well.
Prospect Capital (PSEC -0.14%) and Main Street Capital (MAIN -0.79%) are two BDCs that provide you with monthly income and yields of 6% or higher.
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Prospect Capital provides middle-market privately held companies with loans and investments. Its goal is to generate income through the interest earned and provide investors with a monthly income stream, and it currently yields investors a 9.8% dividend.
Prospect has invested $7.6 billion across 129 private companies that use the money for acquisitions, divestitures, growth, and other purposes.
The company has benefited from higher interest rates, which have translated into higher net interest income (NII). In its annual earnings, ending June 30, Prospect saw its NII come in at $344 million, a 20% increase from last year.
When investing in a BDC, it’s important to remember that there is no sure thing. BDCs can generate strong returns because they use a lot of leverage, which can amplify losses when the economy deteriorates. Some of a BDC’s companies could have trouble paying off their debt if the economy declines.
To manage some of these risks, Prospect uses less debt than other BDCs. In June, its net debt-to-equity ratio was 57%, while BDCs have averaged a net debt-to-equity ratio of around 116%. It also diversifies across industries, with no single industry making up more than 18% of its portfolio. Prospect’s biggest exposure is to equity Real Estate Investment Trusts (REITs). It also invests heavily in first lien debt, meaning it has first claim on collateral pledged by the companies it invests in, which makes up 50% of its portfolio. Another 20% is second lien debt, giving it a second priority claim, and 20% is in equity investments.
While Prospect’s stock is down 35% in the last 10 years, its total return comes to 105%, thanks to its consistent dividend payments. If you’re an income investor willing to tolerate some risk, Prospect Capital could be the stock for you.
Main Street Capital provides lower middle-market companies with loans and investments, much like Prospect Capital. The company works with entrepreneurs and management teams of small companies and provides funds that can help them grow, refinance, or make acquisitions.
Main Street looks to fill a gap in financing to lower middle-market companies that may not be able to obtain loans from big banks, and has a $1.8 billion portfolio across 75 companies. The company has benefited from rising interest rates, which have helped it grow its NII by 26% through the first six months of this year.
As a BDC, the company faces the same risks as Prospect and looks to mitigate these risks in a similar manner. Main Street’s portfolio comprises 74% first lien debt and another 25% of equity investments. The company also limits its exposure across industries, with the machinery industry making up its most significant exposure at 8.7% of its portfolio. It also uses less leverage than the industry, with a debt-to-equity leverage ratio of 81%, below the industry average ratio of 116%.
Main Street’s stock has gained 54% over the last decade, but when you factor in its dividend, its total returns are 230%. With its 6.2% dividend yield and a monthly payout, Main Street Capital is another solid stock income investors should consider.
Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
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