This is a series of articles that will attempt to find the 'best in class' BDCs to include in my updated "Total Return Portfolio" for 2014. Please read "Part 1" for a complete description of the portfolio but basically it is for investors that want dependable regular dividends and the potential for special dividends as well as long-term capital appreciation from increased stock values. The other five portfolios that I cover are: General, Risk Averse, High-Yield, Value, and Underdog. I believe BDCs are prices are based on more than just net asset value ("NAV") per share and earnings multiples, especially for the higher quality companies that return more than just dividends and this article will explain how I value BDCs using returns.
- Part 1: Introduction & Historical Performance
- Part 2: Historical & Projected Dividend Sustainability
- Part 3: Dividend & Portfolio Growth Potential
- Part 4: NAV Growth Potential
- Part 5: Projected Dividend Yields
- Part 6: Projected vs. Expected Returns
Projected & Expected Total Returns
A recent article "Total Return BDCs For 2014: Part 6" combined NAV per share growth with projected dividend yields to come up with projected and expected returns for each BDC (please see the article for details to this methodology). However 10 of the 25 BDCs that I cover have recently reported financial results and I have included the updated projected returns in the table below along with expected returns based on risk profiles. The biggest changes were American Capital (NASDAQ:ACAS) with an abnormal decline in NAV and Apollo Investment (NASDAQ:AINV) that reported favorable results beating EPS estimates for a third quarter in a row and higher NAV growth. Triangle Capital (NYSE:TCAP) has recently announced two special dividends in 2014 (so far) adding 1% to its return. Others such as Prospect Capital (NASDAQ:PSEC) and Fifth Street Finance (NASDAQ:FSC) both reported basically flat NAV growth and in-line EPS as expected and projected returns remained stable. However PSEC's risk profile was lowered from a 6.1 to 4.9 (implies riskier but still close to the average) for the reasons discussed in the "Prospect Capital: February 2014 Report", increasing the amount of expected returns closer to the average of 10.8%.
It is important to note that the table above does not include the potential for dividend increases as discussed in Part 6. I believe this is a more conservative approach when considering pricing based on returns but at the end of this series I will combine all aspects of total return.
Implied Total Return Pricing
Using the projected and expected returns from above I calculate the proper price for each BDC using a simple calculation as shown in the examples below:
In other words: each share of Ares Capital (NASDAQ:ARCC) stock is likely to return $1.98 or 10.7% (mostly from its regular and special dividends) over the next twelve months which means that if an investors is only expecting 9.9% for the amount of risk then the proper price for each share would be closer to $20. In the BlackRock Kelso Capital (NASDAQ:BKCC) example its projected return is lower than expected that would imply a slightly reduced price of around $9.
The table below applies this methodology to the other BDCs, comparing the implied price to current prices and identifies the portfolios I have suggested for each:
Obviously Main Street Capital (NYSE:MAIN) is an outlier even after discounting its large amount of historical NAV growth, that is higher than any other BDC over the last 12 months at over 14%. Solar Capital (NASDAQ:SLRC) is an outlier due to portfolio changes that skew the current dividend and NAV growth lower. Again I was happy to see the current components of this portfolio rank near the top. Gladstone Capital (NASDAQ:GLAD) has the second largest amount of NAV growth over the last 12 months at around 10% but is consider riskier than most BDCs and may be a contender for a higher risk portfolio. PennantPark Investment (NASDAQ:PNNT) is ranked higher than most as well with average amounts of risk.
At the end of this series I will integrate and update with the latest earnings releases/results and combine with these analyses to project total return to shareholders from distributions and price appreciation. Most likely I will split this into two portfolios with one being higher returns and the other more for the risk averse investor and I will most likely be investing in most of these BDCs personally. Investors should only use this information as a starting point for due diligence. See the following for more information: