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BlackRock Kelso Capital Corporation (NASDAQ:BKCC) is a private equity firm specializing in investments in middle market companies in all industries. Typically the firm invests between $10 million to $50 million and can invest more or less in companies with EBITDA or operating cash flow between $10 million and $50 million. The firm invests in the form of senior and junior secured, unsecured, and subordinated debt securities and loan including cash flow, asset backed, and junior lien facilities and equity securities. Equity investments can be structured in the form of warrants, preferred stock, common equity co-investments, and direct investments in common stock. The firm debt investments are principally structured to provide for current cash interest and to a lesser extent non-cash interest, particularly with subordinated debt investments. (Source)

As a shareholder in this firm, I was immediately drawn to it because it has a huge dividend yield of $1.04- or 11.30% per year. It's a smaller company with an enterprise value of $1.09B.

That being said, I want to walk you through my calculations using the price-earnings multiple method of valuation that I got from Value Spreadsheet.

First, I looked at the average historical price-earnings multiple for five years from Morningstar. Therefore, the historical price-earning multiple average came out to 9.8. Second, looking at Yahoo! Finance, the trailing twelve month (TTM) EPS came in at 0.84. Third, we look at the expected growth rate, which according to Nasdaq.com is 19.00%.

We also have to remember to apply the margin of safety principle that was introduced by Benjamin Graham to account for some potential for error. Value Spreadsheet's recommended margin of safety is between 15% to 25%. I like to err on the side of caution and therefore use 25%. Using 25%, we arrive at a growth rate of 14.25% by taking the expected growth rate of 19.00% multiplied by 0.75.

Time to Crunch Numbers

We can calculate the one year price target by taking the EPS multiplied by the calculated growth rate plus the whole to the power of five (as years) multiplied by the historical price-earning multiple. Here are the numbers:

0.84 x 1.1425^5 x 9.8 = $16.03.

That's what the one-year price target is. But let's dig a little deeper to see what the stock is worth today. To arrive at today's price valuation, let's consider a 9% discount rate, which is an approximation relative to the long-term historical return of the stock market over the last 100 years.

Therefore,

$16.03 / 1.09 = $14.71.

Today, the stock price according to this valuation method is $14.71. That's not bad at all! Keep in mind that no one valuation method is entirely on spot, and that each method gives only a rough estimate of the value. Therefore, if you know of other valuation methods that you prefer to use, I encourage you to use the methods that you're comfortable with.

Based on the share price from the market close on Friday, February 7, 2014 of $9.22, the stock is about 37% undervalued!

The Trade

I feel that BlackRock Kelso Capital Corporation is a good buy with this valuation because the share price has an epic upside potential!

Disclosure: I am long BKCC and may purchase more shares within the next week. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Valuing BlackRock Kelso Capital Corporation