Grab 60% Over The Next 9 Years On This Preferred

| About: Prospect Capital (PSEC)
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I had an interesting argument with a colleague of mine. He kept saying dividends are boring and that by investing in preferreds, you miss out on 20%+ gains on growth companies. I wished him the best of luck and told him to continue with his tech stocks and I will continue with my dividend stocks. I don't pretend to understand the market since there is just so many pieces involved. I use my best judgment to help grow my portfolio at a nice pace without having to monitor it every two hours.

That's why I always like dividends. It's something I understand and at the end of the day(or year) you know your portfolio will continue to receive cash. One of the opportunities I recently found has been really intriguing. It can give income investors the chance to get more than 60% in dividends by 2022. This might be a long waiting period for most, so if your not the patient type, this article may not be for you. Personally a 60% return over 9 years is decent to me. It's nice enough where you can put your excess cash in.

The preferred I am referring is the Prospect Capital's 6.95% senior notes. Prospect Capital (NASDAQ:PSEC) issued these preferreds last May. The call date is on 05/2015 and the maturity is 11/2022. The preferreds are trading above par, which makes the yield on cost 6.6%. While I am generally against buying preferreds over par, the long holding period doesn't make it as risky.

Many of you know that Prospect Capital's common has a 12% yield. Considering I even hold common shares, you are probably wondering why I even bother with this. This is a valid argument, but keep in mind these preferreds are essentially senior notes. There is a fixed yield, which will not fluctuate. The timeframe of 9 years is a long holding period and who knows what could happen by then. Sure you won't be getting a high dividend, but you will be in a security with huge protection against risk.

Since there is both a call date and maturity date, there are two scenarios here.

1. Prospect calls the notes two years from now on 5/15/2015.

2. Prospect is forced to redeem at maturity on 11/15/2022.

Under scenario one, investors will be only holding the preferreds for two years. Investors will receive a total dividend of $3.47. Now keep in mind that the preferred is above par, so when called it would drop a little more than a $1. Investors would actually receive a net closer to $2.25. This is a 9% return. Annualize it and investors will earn 4.5% assuming it gets called.

Under scenario two, investors would hold until November 2022. In that time period the total dividends received will be $16.50. Then account for the loss of a $1.20 because of the premium over par. So it's more like 15.30. This gives you a 61% return until it matures. Not a bad return at all.

I don't believe scenario one to be likely since Prospect is still doing record originations and they need the extra capital. Also they were able to lock in a low enough yield, I don't see them wanting to refinance their preferred so early.

So worst case scenario is that Prospect calls it early that you walk away with 9%. If you wait, you will get a total return of 61% holding until maturity. If you reinvest the dividends quarterly into other securities, the return would be much greater.

Investors who are sitting on excess cash and don't really know where to put there money should seriously consider PRY. Even if interest rates rise, principal could fall for the short-term, but eventually you can exit your position when the notes mature. If you can hold the 9.5 years, then it's worth it. Remember that these are senior notes so the company has an obligation to pay the dividends.

Senior notes have a ticker symbol of PRY.

Please be aware I use terms preferreds and notes interchangeably. These are senior notes that are treated as debt not equity. Therefore investors technically receive interest, not dividends. I use interest and dividends interchangeably as well to help avoid confusion.

Disclosure: I am long PSEC. 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.