Prospect Capital Corporation: A 12.38% Dividend With The Earnings To Cover The Expenses

| About: Prospect Capital (PSEC)
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Prospect Capital Corporation (NASDAQ:PSEC) provides capital for midmarket companies, and is also involved in refinancing, acquisitions and leveraged buyouts. Its close competitors include American Capital (NASDAQ:ACAS) and Apollo Investment Corp. (NASDAQ:AINV). The stock has been very volatile for a long period of time, however, it has seemed to fluctuate around $11.00 since the second quarter of 2012. Furthermore, since the beginning of 2010, the stock price has stayed between $8.07 and $12.75, providing a degree of stability for potential investors.

Now that the economy look to be improving, several factors will help PSEC to return value to its shareholders. First off, the economic expansion will particularly fuel the growth of the bulk of midmarket companies, and as Prospect's goal is to invest in these companies, it will benefit them indirectly. Secondly, as the Fed looks to slow down buying up bonds, PSEC will be there to step in and provide financial support to many of these companies that currently depend on the Fed's support. Thirdly, as PSEC is a Business Development Organization, it has rules obliging it to pay out 90% of taxable income directly to shareholders (here-slide4). Therefore, a large portion of its benefit from the economic recovery will go directly to shareholders.

There are some limitations to PSEC's structure. As 90% of taxable income goes back to shareholders, they have a cap on what they can reinvest in capital. Therefore, over the long run, this could limit the growth of the company. PSEC also has a fairly large debt/capital ratio of 32%, however, this is mitigated due to its competitors having roughly the same debt/capital ratio.

PSEC's financials speak for themselves. It has a P/E ratio of 10.4 vs an industry average of 17.7, and it has a forward P/E of just 8.6, which indicates future earnings growth. Its price to book of 1 is half the industry average, although it has exactly the same price to sales. Its margins, however, are much higher. Its operating margin TTM (58%) dwarfs the industry average (23.8%) and its net margin TTM (34%) is equally impressive vs the average (15.4%). It also has a significantly higher ROA (6.0 vs 1.2) although the same debt/equity of 0.5. Over the last three years, on average, revenue has growth 47.3% yearly, and net income has grown 75.9% yearly. Therefore, clearly, PSEC has a significant financial advantage over its competitors.

The huge margins the company generates, allows it to offer a 12.38% dividend, with the dividend projected to reach 12.89% by the end of the year. Personally, even though there is zero growth from the stock, and it is very volatile, $10.36/share is a bargain. PSEC's investment portfolio is very diversified, therefore, over the short run, only macro shocks could drive the stock price down significantly, causing little downside to the stock. The yield adjusted PEG ratio of just 0.42 adds that extra level of security to the current share price. I'm very happy with 12.38% a year in dividend returns, even if the stock does not grow at all.

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.