This is a series of articles to find BDCs to include in my updated "Total Return Portfolio" for Q3 2014. This portfolio 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 returns from this portfolio will most likely be higher and have more favorable tax treatments while requiring less babysitting. However many of the higher return BDCs are priced at a premium with correspondingly lower dividend yields and may involve more risk due to higher amounts of equity investments needed for net asset value ("NAV") per share growth and the potential for realized gains to pay special dividends.
As discussed in my "BDC Investment Philosophy" I consider investing in BDCs as an investment in the overall market with risk levels similar to other equity investments. I do not consider BDCs as simply a financial sector investment but take into account the sector diversity of each portfolio. Each investor has different needs and allocations but I believe that BDCs deserve a large portion of the overall stock allocation. BDCs can be volatile and affected by interest rates in the short term but I believe they will benefit from rising rates given the high amounts of variable rate investments and fixed-rate borrowings.
Total return accounts for income and capital appreciation. Income includes regular and special dividends and capital appreciation represents the change in the value of the investment. There are a few ways to project total return but I use a method that ignores general changes in market multiples unless the company is responsible for the specific changes in the multiples that investors are willing to pay. I use changes in NAV per share and EPS as a measure of potential capital appreciation instead of actual stock price changes. However when evaluating performance I still use actual stock price appreciation. When evaluating potential dividends I look at current dividends, dividend growth history, and projected EPS to cover dividends and possibly grow or pay special dividends. I recently compared the dividend coverage potential for Prospect Capital (NASDAQ:PSEC) to other BDCs in my article "PSEC: BDC Dividend Coverage Part 18". I will be taking into account the 'optimal leverage' analysis discussed in this series to assess which BDCs are most likely to cut or grow dividends in the next twelve months.
The following are the key criteria I will be analyzing for this portfolio:
- Regular dividend yield and sustainability
- Dividend and portfolio growth potential
- Special dividend potential
- Relative valuations
- Risk to reward ratio
- NAV per share growth historically and projected
I will try to cover each of these areas using available public information as well as my own analysis and I will most likely be investing in all of these BDCs personally.
Currently, the BDCs that are components in the total return portfolios are Main Street Capital (NYSE:MAIN), Hercules Technology Growth Capital (NASDAQ:HTGC), FS Investment Corp (NYSE:FSIC), New Mountain Finance (NYSE:NMFC), TCP Capital (NASDAQ:TCPC), Gladstone Capital (NASDAQ:GLAD), PennantPark Investment (NASDAQ:PNNT) and Ares Capital (NASDAQ:ARCC). Two other BDCs that I have recently upgraded are PSEC and Apollo Investment (NASDAQ:AINV) that will both be considered for these portfolios due to higher total return potential. Some of the higher quality BDCs that were contenders last quarter will also be considered due to better pricing or performance such as Golub Capital BDC (NASDAQ:GBDC) and Triangle Capital (NYSE:TCAP).
The following table shows the current dividend yield and NAV growth over the last twelve months. As you can see all of the previously mentioned BDCs are at the top of the list.
The other four portfolios that I will cover in following articles are 'High Yield', 'Risk Averse', 'Value' and the 'Underdog' portfolios that will be updated on my "Portfolio Updates" page . Investors should only use this information as a starting point for due diligence and please see the following for more information:
Disclosure: The author is long ARCC, MAIN, FSC, FSIC, HTGC, TCPC, NMFC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.