Lessons Learned From My Investment In High-Yield Dividend Mad Dog Prospect Capital

| About: Prospect Capital (PSEC)

Summary

I reflect on my investment in high-risk BDC Prospect Capital.

I discuss the lessons learned from investing in an unpopular high-yield income play.

An investment in PSEC continues to yield ~12 percent.

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In February of last year I bought a stake in business development company Prospect Capital Corp. (NASDAQ:PSEC). At the time I started the $100,000 high-yield income portfolio that I kicked off with a large allocation of funds to Prospect Capital (I bought 2,000 shares for an average purchase price of $8.79), and to mortgage investment company New Residential Investment Corp. (NYSE:NRZ) of which I bought 1,100 shares (I later added New Residential on the sell-off).

There were a few reasons why I bought Prospect Capital for my high-yield income portfolio more than a year ago, and among them were the following:

  • Investor confidence was low at the time I bought Prospect Capital because the BDC cut its dividend at the end of 2014, which led to a widening of the BDC's Net Asset Value discount. I bought Prospect Capital at a ~15 discount to Net Asset Value, a solid margin of safety (so I thought).
  • There was a low probability of another near-term dividend cut IMO because the business development company already reset its dividend in expectation of lower investment yields and lower Net Investment Income moving forward.
  • An investment in Prospect Capital came with positive interest rate sensitivity.
  • Last but not least, Prospect Capital afforded me with an ~11 percent dividend yield at the time, and that dividend looked sustainable.

You can find the original article, which drew a lot of passionate responses from both sides of the aisle, right here: 'Building A $100,000 High-Yield Income Portfolio From Scratch, Adding Position 1: Prospect Capital'.

Fast forward one-and-a-half years, and it is time to look at the investment, and, most importantly, reflect on the lessons that I have learned from my investment in Prospect Capital.

Here are the takeaways:

  • A BDC stock that already sells for a sizable discount to Net Asset Value can go even lower if investors harbor doubts about the health of the loan portfolio or the dividend.
  • Always be prepared for volatility, and be certain that you can deal with it. Either buy more shares when they are on sale (if you have the cash), or take a deep breath and sit the volatility out. Selling into weakness is not a good (or lucrative) investment strategy over the long haul.
  • It is important to have a clear motive when buying a stock. Mine was clear: I bought Prospect Capital for the dividend, first and foremost, like most income investors. This focus on the dividend helped me a lot dealing with the market meltdown at the beginning of the year. When you know what you want to get out of an investment (such as dividend income), you are so much harder to influence by market swings. That's a huge ADVANTAGE when it comes to investing.
  • Prospect Capital could hardly win a popularity contest today, but it really doesn't have to. As long as the company pays a handsome dividend that is covered by Net Investment Income, there will be investors out there willing to buy.
  • Investor sentiment is a fragile thing, and it can change very quickly. Never invest in a stock purely because others invest in it. Don't reject an investment just because others reject the investment. Do your own research, and form your own opinion.
  • Investors very much underestimate the value of (high) dividend income during periods of market volatility. There is nothing nicer and more satisfying than getting a regular dividend paycheck when everyone around you is melting down.
  • If you have a long term investment goal (mine is financial independence) there is no need at all to check your portfolio and stock prices compulsively every day. Again, that's a big advantage.
  • Emotionally-fueled market sell-offs are ALWAYS very compelling buying opportunities.
  • Most importantly: Calm down.

Your (Final) Takeaway

Obviously, there are a lot of investors out there that don't like Prospect Capital very much, and that's OK. But Prospect Capital clearly has not performed nearly as badly as predicted by many more skeptical income investors: YTD, Prospect Capital's shares have risen ~18 percent.

Prospect Capital has been an insightful case study for me about how to deal with volatility, bad investor sentiment, and the psychology of Mr. Market. As far as I am concerned, Prospect Capital continues to deserve the benefit of the doubt, and I am going to continue to hold on to the business development company as long as the shares throw off a fairly decent dividend. Buy for income and capital appreciation.

If you like to read more of my articles, and like to be kept up to date with the companies I cover, I kindly ask you that you scroll to the top of this page and click 'follow'. I am largely investing in dividend paying stocks, but also venture out occasionally and cover special situations that offer appealing reward-to-risk ratios and have potential for significant capital appreciation. Above all, my immediate investment goal is to achieve financial independence.

Disclosure: I am/we are long PSEC, NRZ.

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.