The Top 3 BDCs for Income Now

There are many different sectors in the stock market that can provide investors the income they seek, but the way that income is achieved can vary quite widely. Certain sectors tend to offer better dividend growth prospects, while others offer exceptional dividend safety. If an investor is looking for especially high dividend yields, however, the options are somewhat more limited. Business development companies, or BDCs, offer investors a way to gain exposure to very high-yielding stocks that exist essentially as income-generation vehicles. Here, we'll look at why we like BDCs for income investors, and three examples of top BDCs that are available today. Why BDCs? BDCs are closed-end investment firms that are publicly traded. The business model is fairly simple in that BDCs make debt and equity investments in middle-market or smaller companies that cannot access capital markets themselves. That means BDCs function somewhat like a bank or other lenders in that they borrow money from the capital markets and then lend it out at higher rates, earning a spread. BDCs also generate some earnings from capital gains, but they are primarily high-yield lenders. The reason they are attractive for investors is that this high-yield lending can generate strong returns, which the BDC then passes on to shareholders. BDCs as a group generally have dividend yields that are many times that of the broader market, with most BDCs showing at least 5% dividend yields. BDCs aren't without their risks, which include heavy amounts of leverage, the underlying strength (or weakness) of portfolio companies, and movements in the interest rate curve. But if one can accept those risks through proper due diligence, we believe BDCs are attractive for income-focused investors. Newtek Business Service Our first BDC is Newtek Business Service Corp. , a company that provides financial and business services to small and medium-sized companies in the US. Newtek also invests in early-stage companies. Like most BDCs, Newtek makes both debt and equity investments, the former of which can have terms up to 25 years. Newtek has an electronic payment processing business and managed technology solutions, in addition to its lending business. This means it's a bit more diversified than a typical BDC that just lends money. Newtek was incorporated in 2013, should generate about $70 million in revenue in 2022, and trades with a market capitalization of $628 million. We like Newtek because it has a reasonable valuation, a well-covered distribution, and an extremely high dividend yield. Newtek reports net investment income per share, or NII, in lieu of traditional earnings per share, which is common among BDCs given earnings in a GAAP sense don't really work for the business model. We estimate for the as yet unreported full-year 2021 that Newtek produced $3.30 in NII per-share, and given that the company returns substantially all of that to shareholders, it means the distribution for last year totaled $3.15 per share. That was a record distribution by a long way for Newtek, so its dividend yield on a 12-month basis is in excess of 12%. The distribution is variable based upon each quarter's NII per share, so we don't know how much Newtek will ultimately pay in 2022. However, the first dividend was declared at 65 cents per share, which is 15 cents in excess of the comparable dividend last year. Newtek is also trading below our estimate of fair value on an NII per-share basis, so we see investors as getting good value for their investment capital, as well as an outstanding yield. Great Elm Capital Our next stock is Great Elm Capital , a BDC that lends to middle market companies, with most of its investments coming in the form of debt, and a small amount of equity investments. Great Elm is fairly well diversified in the industries it lends to, whereas some other BDCs tend to focus on specific sectors. Great Elm was founded in 2016, generates about $32 million in annual revenue, and trades with a market capitalization of $84 million. Given these figures, Great Elm is certainly on the smaller end of the scale when it comes to BDCs. Great Elm is attractive today because the valuation has declined substantially in recent months, given very weak action in the share price. This has driven the valuation lower, but has also raised the dividend yield investors receive when purchasing the stock. The company has seen declining earnings and dividends each year since its formation, but the share price decline has produced a price-to-book of less than 80%, and a current yield of nearly 13%. While Great Elm carries with it increased risk due to its diminutive size and spotty history of earnings, the combination of an attractive valuation and extremely high yield make it worth a look for income investors. Horizon Technology Finance Our third stock is Horizon Technology Finance , a BDC that specializes in lending and investing equity in development-stage companies. Horizon makes secured debt and venture lending investments in technology, life science, cleantech, and healthcare information sectors. In this way, Horizon is a specialized BDC, rather than a diversified one. Horizon was founded in 2008, generates $63 million in annual revenue, and trades for a market capitalization of $300 million. Like the others on this list, Horizon's recent share price decline has improved the valuation substantially, and shares trade at about 93% of fair value. That has reduced the risk of buying the stock, and driven the dividend yield up as well, which now stands at 8.2%. While that yield is lower than the others on this list, Horizon has a strong history of rather predictable earnings for a BDC, and therefore, a fairly predictable payout schedule. The stock is still below fair value, however, and it still yields almost seven times that of the S&P 500, so we still find it to be an attractive BDC. Final Thoughts While investing in BDCs is not without its risks, we think that if investors perform due diligence in the sector, there are attractive bargains to be had. We see Newtek, Great Elm, and Horizon as providing different ways to benefit from exposure to the sector, with three different approaches to running a BDC, producing three different results. They all offer reasonable or cheap valuations, as well as extremely high yields. Therefore, for investors looking to generate strong yields, we believe these three are worth a look.

The Top 3 BDCs for Income Now

Business development companies offer a way to gain exposure to very high-yielding stocks that exist essentially as income-generation vehicles.

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