Don’t Forget BDCs for Stable, High-Yield Income

Don’t Forget BDCs for Stable, High-Yield Income

Posted On October 18, 2023 9:28 am

The Fed’s aggressive interest rate increases have been good for business development companies (BDCs). I have been recommending select BDC stocks all year and want to make clear that the investment potential remains very attractive.

Let me show you why – and give you one of my favorite BDCs…

Congress passed the BDC rules to provide non-bank funding sources for small to medium-sized corporations. A BDC will primarily make client company loans and may also take on equity stakes. The rules governing BDCs limit the debt leverage allowed. These companies almost exclusively make variable-rate loans to client companies. As a result, when interest rates increase, a BDC’s net income also increases.

A BDC must pay shareholders at least 90% of its net interest income as dividends. These will be high-yield stocks, with many yielding near or over 10%.

There is one analysis mistake you will see with BDC analysis. Pundits will recommend specific BDCs because they trade at a discount to net asset (NAV) or book value. The opposite is true. You want to invest in BDCs that trade at a premium to NAV.

Because of the debt limit restrictions, for a BDC to grow, it must sometimes issue equity or shares to raise the equity base. A BDC that trades at a premium literally makes free money when it issues shares worth more than the current book value. A BDC trading at a discount will hurt book value with any equity issuance.

Also, the highest quality, best-managed BDCs typically trade at a premium-to-book value. Investors familiar with the BDC business type understand that…

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