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What should one do? Is it better to play it safe with a well liked, but lower yielding BDC like Ares Capital Corporation (NASDAQ:ARCC)? Or will it be better to capture the maximum yield with a BDC like Prospect Capital Corporation (NASDAQ:PSEC)? Even a very detailed oriented investor like me will lean on some simple rules in making that decision.

There are many investors who do not handle nuance and detail well. These are also investors that lack the time to put much effort into investing. There have been decades where I fell into that category. What they want are a few simple rules that tend to work. This is an article for those kinds of investors. The lesson can be put in easy to understand and easy to implement words - do not invest is BDCs that have lower than average analyst ratings and inferior dividend coverage ratios because those two attributes lead to below average returns. This article will provide the data to back those two conclusions.

If you gather your own data then you can parse your own data. And the act of parsing stocks by metric attribute assists in listening to the lessons the data is telling us. The data is always telling us something. Once a year I take a short pause to listen to the data. Here are some of the stories the data is telling me about 2013, along with the findings from 2012 and 2011. I will start with the raw returns for 2013 and quickly start the data parsing.

BDCs 12-31-13

Yield in the spreadsheet below is based on the Q4-13 dividend. Spreadsheet header abbreviations: Div = dividend; EPS = earnings per share; LTM = last twelve months; YTD = year to date. The dividend to EPS ratio is a measure of dividend safety. Due to calendar and fiscal years failing to overlap, I also include a dividend to the sum of the last four quarters of NII - in the Div/NIIltm column. The dividend to NAV ratio is a measure of safety and efficiency. The last four columns measure the percentage change in the 2013 EPS projection and the change in the price target since the beginning of the year; the change in the Q4-13 dividend from the Q4-12 dividend. Special dividends are not included in this data. ARCC will pay a special dividend of $0.05/share payable on 12-31-13 and again on 3-28-14. FDUS will pay a special dividend of $0.38/share payable 12-20-13. MAIN will pay a special dividend of $0.25/share on 12-24-13. FSC and FULL have cut their first quarter dividend - and that new rate is temporarily encoded as a Q4-12 div to show their forward yield.


Share Price Div/Div/Div/Div/Q3-13PriceYTD Percent ChangeLTMLTM
Company_name_and_ticker1-0112-31YieldEPS13EPS14NIIltmNAVNAVNAVPricePr+DivEPSTargetDivNAV

American Cap(NASDAQ:ACAS)12.0215.640.000.00.00.00.019.540.8030.1230.12-20.9522.32na12.36
Apollo Invest(NASDAQ:AINV)8.368.489.4396.490.993.49.88.301.021.4411.00-5.685.090.00-1.78
Ares Capital 17.5017.778.5592.791.694.99.416.351.091.5410.23-1.202.960.003.88
BlackRock(NASDAQ:BKCC)10.069.3311.15133.3110.6149.711.19.380.99-7.263.08-22.770.810.00-1.78
Fidus Invest(NASDAQ:FDUS)16.4521.746.99110.985.4109.39.515.981.3632.1641.40-19.8818.920.004.65
Fifth St(NASDAQ:FSC)10.429.2510.8199.097.098.810.19.850.94-11.23-1.64-9.01-5.94-13.05-0.71
Full Circle(NASDAQ:FULL)7.437.0411.93109.1107.7114.210.57.480.94-5.256.06-4.9410.00-9.09-12.10
Gladstone Inv(NASDAQ:GAIN)6.968.067.4488.284.572.57.09.120.8815.8024.4323.64-11.110.002.13
Golub Cap(NASDAQ:GBDC)15.9819.116.7099.293.498.98.515.211.2619.5927.600.785.880.004.18
Gladstone Cap(NASDAQ:GLAD)8.169.578.7895.5100.095.49.89.810.9817.2827.572.330.000.009.85
Horizon(NASDAQ:HRZN)14.9214.219.71100.095.299.59.314.950.95-4.764.49-9.21-5.950.00-8.90
Hercules(NYSE:HTGC)11.1316.406.8391.186.295.311.110.421.5747.3557.4112.8438.7616.6710.62
Kayne Ander(NYSE:KED)24.4427.976.5175.870.893.36.927.841.0014.4421.8925.0022.795.8116.49
Kohlberg(NASDAQ:KCAP)9.198.0713.88123.1109.8123.413.68.021.01-12.190.00-10.78-1.6816.672.56
Main St.(NYSE:MAIN)30.5132.695.6992.581.691.19.920.011.637.1513.24-1.4725.383.3314.41
Medley Cap(NYSE:MCC)14.5613.8510.6996.794.396.711.612.701.09-4.885.295.522.862.780.79

Share Price Div/Div/Div/Div/Q3-13PriceYTD Percent ChangeLTMLTM
Company_name_and_ticker1-0112-31YieldEPS13EPS14NIIltmNAVNAVNAVPricePr+DivEPSTargetDivNAV

MCG Capital(NASDAQ:MCGC)4.604.4011.36113.6102.0118.99.75.100.86-4.356.52-4.357.99-10.711.59
New Mountain(NYSE:NMFC)14.9015.049.0489.598.697.89.514.321.050.9410.0711.761.500.001.56
NGP Capital(NASDAQ:NGPC)7.227.478.57100.0103.2101.47.09.220.813.4612.33-17.95-16.670.00-4.95
Prospect(PSEC)10.8711.2211.8084.3104.390.512.410.721.053.2215.405.3710.120.32-1.47
Pennant Float(NASDAQ:PFLT)12.7013.737.8798.294.792.37.714.100.978.1116.610.006.435.880.86
Pennant Cap(NASDAQ:PNNT)10.9911.609.66110.9102.8110.710.710.491.115.5515.74-10.620.510.002.64
Saratoga(NYSE:SAR)15.4015.650.000.00.00.00.023.770.661.621.62-2.110.00na-12.61
Solar Cap(NASDAQ:SLRC)23.9122.557.1084.790.475.67.122.251.01-5.691.00-26.46-4.84-33.33-1.98
Solar Senior(NASDAQ:SUNS)18.6618.227.74119.5104.4116.07.717.911.02-2.365.20-16.901.320.00-3.71
Medallion(NASDAQ:TAXI)11.7414.356.4180.778.0143.69.010.381.3822.2330.077.5536.009.524.22
Triangle Cap(NYSE:TCAP)25.4927.657.8196.093.992.613.815.941.738.4716.95-0.4415.451.893.98
THL Credit(NASDAQ:TCRD)14.7916.498.2593.895.194.110.313.381.2311.4920.691.409.113.031.29
TICC Cap(NASDAQ:TICC)10.1210.3411.22111.5102.7116.511.99.901.042.1713.64-14.75-4.480.000.51

Sector Average 8.9699.5 9.8 1.086.7715.45-3.566.67

With the 10 Treasury at 3.03% and sector average yield (on Q4 dividends) at 8.96% - the spread is 593 bps.
The cap weighted ETF BDCS is up 7.25% year to date - with dividends its total return is 14.72%.
Sector yield, Dividend/NAV and Dividend/EPS ratio filter out the zero payout ACAS and SAR.
Weeding out ACAS and SAR, the average share price gain is 6.09%.

Note - The data output found below is based on "at the start of the year" data for earning projections and ratings.

Let's start with consensus analyst ratings.

2013 data - The following companies had ratings under 2.5 - or the better rated BDCs - at the beginning of the year: ACAS, ARCC, FDUS, GAIN, GBDC, HRZN, HTGC, MCC, NMFC, PFLT, PNNT, SLRC, SUNS, TAXI, TCRD and TICC. Their mean price gain for the year was 11.21%. Their mean total return for the year was 19.62% - and 8 of the 16 beat the sector median yearly price gain.

The following companies had ratings of 2.5 or more - or the lesser rated BDCs - at the beginning of the year: AINV, BKCC, FSC, FULL, GLAD, KED, KCAP, MAIN, MCGC, NGPC, PSEC, SAR and TCAP. Their mean price gain for the year was 1.29%. Their mean total return for the year was 10.31% - and 4 of the 13 beat the sector median yearly price gain.

2012 data - The following companies had ratings under 2.5 - or the better rated BDCs - at the beginning of the year: ACAS, ARCC, BKCC, FDUS, FSC, HTGC, KED, KCAP, MAIN, MCC, MCGC, PFLT, PNNT, SLRC, SUNS and TCAP. Their mean price gain for the year was 26.23%. Their mean total return for the year was 36.7% - and 9 of the 16 beat the sector median yearly price gain.

The following companies had ratings of 2.5 or more - or the lesser rated BDCs - at the beginning of the year: AINV, FULL, GAIN, GBDC, GLAD, HRZN, NMFC, NGPC, PSEC, SAR, TAXI, TCRD and TICC. Their mean price gain for the year was 9.83%. Their mean total return for the year was 19.56% - and 3 of the 13 beat the sector median yearly price gain.

2011 data - The following companies had ratings under 2.5 - or the better rated BDCs - at the beginning of the year: AINV, ARCC, BKCC, FSC, GAIN, HTGC, KED, MAIN, NGPC, PSEC, PNNT, SLRC, TCAP, TICC and TTO. Their mean price gain for the year was -9.99%. Their mean total return for the year was -1.01% - and 8 of the 15 beat the sector median yearly price gain.

The following companies had ratings of 2.5 or more - or the lesser rated BDCs - at the beginning of the year: ACAS, GLAD, KCAP, MCGC, SAR and TAXI. Their mean price gain for the year was -14.47%. Their mean total return for the year was -8.44% - and 3 of the 6 beat the sector median yearly price gain.

2011 was the only year where analyst ratings failed to be predictive "in a major way" of future returns. The inclusion of AINV - which fell 41.82% in share price during the year - hurt the return for the superiorly rated group.

Next, I will go on a tangent and look at the correlation between NAV (Net Asset Value) Growth and total returns.

2013 data - The following companies had NAVs that rose more than 4% from Q3-12 to Q3-13: ACAS, FDUS, GBDC, GLAD, HTGC, KED, MAIN and TAXI. Their mean price gain for the year was 23.79%. Their mean total return for the year was 31.16% - and 8 of the 8 beat the sector median yearly price gain.

The following companies had NAVs that rose from Q3-12 to Q3-13 - but rose less than 4%: ARCC, GAIN, KCAP, MCC, MCGC, NMFC, PFLT, PNNT, TCAP, TCRD and TICC. Their mean price gain for the year was 2.97%. Their mean total return for the year was 12.74% - and 4 of the 11 beat the sector median yearly price gain.

The following companies had shrinking NAVs: AINV, BKCC, FSC, FULL, HRZN, NGPC, PSEC, SAR, SLRC and SUNS. Their mean price gain for the year was -2.68%. Their mean total return for the year was 5.86% - and 0 of the 10 beat the sector median yearly price gain.

2012 data - The following companies had NAVs that rose more than 4% from Q3-11 to Q3-12: ACAS, AINV, ARCC, KED, MAIN, NMFC, PSEC, PFLT, SLRC, TCAP and TICC. Their mean price gain for the year was 26.31%. Their mean total return for the year was 36.11% - and 5 of the 11 beat the sector median yearly price gain.

The following companies had NAVs that rose - but less than 4% from Q3-11 to Q3-12: FDUS, GBDC, MCC, NGPC, PNNT, SUNS, TAXI and TCRD. Their mean price gain for the year was 15.25%. Their mean total return for the year was 25.38% - and 4 of the 8 beat the sector median yearly price gain.

The following companies had NAVs that fell from Q3-11 to Q3-12: BKCC, FSC, FULL, GAIN, GLAD, HRZN, HTGC, KCAP, MCGC and SAR. Their mean price gain for the year was 13.61%. Their mean total return for the year was 24.12% - and 3 of the 10 beat the sector median yearly price gain.

2011 data - The following companies had NAVs that rose from Q3-10 to Q3-11: ACAS, ARCC, GAIN, HTGC, KED, MAIN, PSEC, TAXI, TCAP, TICC and TTO. Their mean price gain for the year was 1.6%. Their mean total return for the year was 9.51% - and 9 of the 11 beat the sector median yearly price gain.

The following companies had shrinking NAVs: AINV, BKCC, FSC, GLAD, KCAP, MCGC, NGPC, PNNT, SAR and SLRC. Their mean price gain for the year was -25.42%. Their mean total return for the year was -17.04% - and 2 of the 10 beat the sector median yearly price gain.

Summing the individual events for the last three years, 22 of the 30 BDCs in the top tier of NAV growth - or 73.3% - beat the sector average. While one cannot project with 100% accuracy the BDCs that are going to have the best NAV growth, one can use logic to select a group with superior odds of reaching that goal. And BDCs with the best dividend coverage ratios should also be the ones with best chance of superior NAV growth.

Let's end with a look at the importance of "projected" dividend coverage.

2013 data - The following BDCs had projected dividend coverage of over 109% based on the 2013 NII (Net Investment Income) projections at the beginning of the year: ACAS, AINV, ARCC, FDUS, GAIN, GLAD, HRZN, HTGC, KED, MAIN, NGPC, PSEC, SAR and TAXI. Their mean price gain for the year was 13.79%. Their mean total return for the year was 21.51% - and 8 of the 14 beat the sector median yearly price gain.

The following BDCs had projected dividend coverage of over 100% but less than 109% based on the 2013 NII projections at the beginning of the year: KCAP, MCC, PFLT, PNNT, SLRC, SUNS, TCAP, TCRD and TICC. Their mean price gain for the year was 1.19%. Their mean total return for the year was 10.57% - and 3 of the 9 beat the sector median yearly price gain.

The following companies did not have projected dividend coverage at the beginning of the year: BKCC, FSC, FULL and MCGC. Their mean price gain for the year was -7.02%. Their mean total return for the year was 3.51% - and 0 of the 4 beat the sector median yearly price gain.

2012 data - The following BDCs had projected dividend coverage of over 112% based on the 2012 NII projections at the beginning of the year: ACAS, FDUS, GAIN, GLAD, HTGC, KCAP, MAIN, MCC, PFLT, PNNT, SAR, SUNS, TAXI, TCAP and TCRD. Their mean price gain for the year was 25.89%. Their mean total return for the year was 35.04% - and 10 of the 15 beat the sector median yearly price gain.

The following BDCs had projected dividend coverage of over 100% but less than 112% based on the 2012 NII projections at the beginning of the year: ARCC, KED, NMFC and SLRC. Their mean price gain for the year was 11.69%. Their mean total return for the year was 21.41% - and 0 of the 4 beat the sector median yearly price gain.

The following companies did not have projected dividend coverage at the beginning of the year: AINV, BKCC, FSC, FULL, GBDC, HRZN, MCGC, NGPC and PSEC. Their mean price gain for the year was 10.61%. Their mean total return for the year was 22.2% - and 2 of the 9 beat the sector median yearly price gain.

2011 data - The following BDCs had projected dividend coverage of over 118% based on the 2011 NII projections at the beginning of the year: ACAS, GAIN, GLAD, HTGC, KED, MAIN, MCGC, NGPC, SAR, TAXI and TTO. Their mean price gain for the year was -6.09%. Their mean total return for the year was 0.58% - and 7 of the 11 beat the sector median yearly price gain.

The following BDCs had projected dividend coverage of over 100% but less than 118% based on the 2011 NII projections at the beginning of the year: ARCC, PNNT and TICC. Their mean price gain for the year was -15.57%. Their mean total return for the year was -6.83% - and 1 of the 3 beat the sector median yearly price gain.

The following companies did not have projected dividend coverage at the beginning of the year: AINV, BKCC, FSC, KCAP, PSEC, SLRC and TCAP. Their mean price gain for the year is -17.56%. Their mean total return for the year is -7.38% - and 3 of the 7 beat the sector median yearly price gain.

Summing the individual events for the last three years, 25 of the 40 BDCs in the top tier of dividend coverage - or 62.5% - beat the sector average. Doing the same sum for the better rated BDCs, 25 of the 47 top rated BDCs - or 53.2% - beat the sector average. The degree that the better group beat the lesser group is substantial. But if you are only going to buy one or two BDCs, then your odds of randomly choosing one of the correct superior performers is just not that high.

That was the bad news - now for the good news. Let's do the same test for the bottom tier. Summing the individual events for the last three years, 9 of the 36 BDCs in the lowest two tiers of dividend coverage - or 25% - beat the sector average. Doing the same sum for the lesser rated BDCs, 10 of the 32 lower rated BDCs - or 31.25% - beat the sector average. Both the dividend coverage metric and the consensus analyst ratings do a reasonably good job at telling us what not to buy. To paraphrase Yogi Berra, 90% of being a good investor is avoiding mistakes - the other half is making a series of good decisions. The historical record strongly suggests that the use of analyst ratings and coverage ratios assists in avoiding mistakes.

I will end by answering the question posted at the start. Is it better to play it safe with a well liked, but lower yielding BDC like Ares Capital Corporation? Or will it be better to capture the maximum yield with a BDC like Prospect Capital Corporation? Ares starts the year the superior dividend coverage and a superior analyst rating. Prospect starts the year with a fiscal 2014 NII projection well below its dividend and an analyst rating that is just below sector average. Ares has a trend of a small amount of NAV growth over the last twelve months. While NAV is mostly stable for Prospect, the last twelve-month change is slightly falling. As long as Prospect's NAV is mostly stable, the dividend is safe. As long as the dividend is stable, the near 12% yield that Prospect currently offers should lead to superior total returns in calendar 2014. That is what happened in 2013. On the other hand, the simple rules are telling me to own ARCC and avoid PSEC.

Source: Simple Rules That Work In BDC Investing