Updated on November 13th, 2023 by Bob Ciura
Business Development Companies, otherwise known as BDCs, are highly popular among income investors. BDCs widely have high dividend yields of 5% or higher.
This makes BDCs very appealing for income investors such as retirees. With this in mind, we’ve created a list of BDCs.
You can download your free copy of our BDC list, along with relevant financial metrics such as P/E ratios and dividend payout ratios, by clicking on the link below:
Of course, before investing in BDCs, investors should understand the unique characteristics of the sector.
This article will provide an overview of BDCs. It will also list our top 5 BDCs right now as ranked by expected total returns in The Sure Analysis Research Database.
Table Of Contents
The table of contents below provides for easy navigation of the article:
Overview of BDCs
Business Development Companies are closed-end investment firms. Their business model involves making debt and/or equity investments in other companies, typically small or mid-size businesses.
These target companies may not have access to traditional means of raising capital, which makes them suitable partners for a BDC. BDCs invest in a variety of companies, including turnarounds, developing, or distressed companies.
BDCs are registered under the Investment Company Act of 1940. As they are publicly-traded, BDCs must also be registered with the Securities and Exchange Commission.
To qualify as a BDC, the firm must invest at least 70% of its assets in private or publicly-held companies with market capitalizations of $250 million or below.
BDCs make money by investing with the goal of generating income, as well as capital gains on their investments if and when they are sold.
In this way, BDCs operate similar business models as a private equity firm or venture capital firm.
The major difference is that private equity and venture capital investment is typically restricted to accredited investors, while anyone can invest in publicly-traded BDCs.
Why Invest In BDCs?
The obvious appeal for BDCs is their high dividend yields. It is not uncommon to find BDCs with dividend yields above 5%. In some cases, certain BDCs provide 10%+ yields.
Of course, investors should conduct a thorough amount of due diligence, to make sure the underlying fundamentals support the dividend.
As always, investors should avoid dividend cuts whenever possible. Any stock that has an abnormally high yield is a potential danger.
Indeed, there are multiple risk factors that investors should know before they invest in BDCs. First and foremost, BDCs are often heavily indebted. This is commonplace across BDCs, as their business model involves borrowing to make investments in other companies. The end result is that BDCs are often significantly leveraged companies.
When the economy is strong and markets are rising, leverage can help amplify positive returns. However, the flip side is that leverage can accelerate losses as well, which can happen in bear markets or recessions.
Another risk to be aware of is interest rates. Since the BDC business model heavily utilizes debt, investors should understand the interest rate environment before investing. For example, rising interest rates can negatively affect BDCs if it causes a spike in borrowing costs.
That said, BDCs may benefit from falling interest rates. In the current climate of low interest rates, many BDCs could see a tailwind.
Lastly, credit risk is an additional consideration for investors. As previously mentioned, BDCs make investments in small to mid-size businesses.
Therefore, the quality of the BDC’s portfolio must be assessed, to make sure the BDC will not experience a high level of defaults within its investment portfolio. This would cause adverse results for the BDC itself, which could negatively impact its ability to maintain distributions to shareholders.
Another unique characteristic of BDCs that investors should know before buying is taxation. BDC dividends are typically not “qualified dividends” for tax purposes, which is generally a more favorable tax rate. Instead, BDC distributions are taxable at the investor’s ordinary income rates, while the BDC’s capital gains and qualified dividend income is taxed at capital gains rates.
After taking all of this into account, investors might decide that BDCs are a good fit for their portfolios. If that is the case, income investors might consider one of the following BDCs.
Tax Considerations Of BDCs
As always, investors should understand the tax implications of various securities before purchasing. Business Development Companies must pay out 90%+ of their income as distributions. In this way, BDCs are very similar to Real Estate Investment Trusts.
Another factor to keep in mind is that approximately 70% to 80% of BDC dividend income is typically derived from ordinary income. As a result, BDCs are widely considered to be good candidates for a tax-advantaged retirement account such as an IRA or 401k.
BDCs pay their distributions as a mix of ordinary income and non-qualified dividends, qualified dividends, return of capital, and capital gains.
Returns of capital reduce your tax basis. Qualified dividends and long-term capital gains are taxed at lower rates, while ordinary income and non-qualified dividends are taxed at your personal income tax bracket rate.
The Top 5 BDCs Today
With all this in mind, here are our top 5 BDCs today, ranked according to their expected annual returns over the next five years.
BDC #5: Monroe Capital Corporation (MRCC)
5-year expected annual return: 12.4%
Monroe Capital Corporation is a specialty finance company focused on providing financing solutions primarily to lower middle-market companies in the United States and Canada. It is externally managed by Monroe Capital and has chosen to be treated as a development company (BDC). The company primarily invests in senior and “unitranche” secured loans ranging between $2.0 million and $25.0 million each.
On November 8th, 2023, Monroe Capital Corporation reported its Q3 results for the period ending September 30th, 2023. Total investment income for the quarter came in at $15.6 million, compared to $16.3 million in the previous quarter. While the average portfolio yield increased during the quarter as a result of the rising rate environment, this increase in average portfolio yield was offset by a one-time reversal of previously accrued fee income associated with a certain investment during the quarter.
Net investment income per share came in at $0.25, two cents lower from last quarter’s $0.27. The decline was due to lower total investment income. Net asset value (NAV) per share fell 2.6% to $9.58 during the quarter, primarily due to net unrealized losses on a couple of specific portfolio companies.
Click here to download our most recent Sure Analysis report on MRCC (preview of page 1 of 3 shown below):
BDC #4: Prospect Capital (PSEC)
5-year expected annual return: 13.3%
Prospect Capital Corporation is a Business Development Company, or BDC, that provides private debt and private equity to middle–market companies in the U.S. The company focuses on direct lending to owner–operated companies, as well as sponsor–backed transactions.
Prospect invests primarily in first and second lien senior loans and mezzanine debt, with occasional equity investments.
Source: Investor Presentation
Prospect Capital posted fourth quarter and full-year earnings on August 29th, 2023, and results were somewhat weaker than expected. Net investment income was up from the prior quarter and the year-ago quarter, as originations more than doubled. However, results missed consensus estimates. Net investment income for the quarter was $113 million, or 23 cents per share. That missed estimates by a penny, but was up from 21 cents.
Click here to download our most recent Sure Analysis report on PSEC (preview of page 1 of 3 shown below):
BDC #3: Gladstone Capital (GLAD)
5-year expected annual return: 13.5%
Gladstone Capital primarily invests in small and medium businesses. These investments are made via a variety of equity (10% of portfolio) and debt instruments (90% of portfolio), generally with very high yields.
Loan size is typically in the $7 million to $30 million range and has terms up to seven years. The BDC’s stated purpose is to generate income it can distribute to its shareholders.
Source: Investor Presentation
Gladstone posted third quarter earnings on July 26th, 2023, and results were ahead of expectations on both the top and bottom lines. Net investment income per share was 31 cents, which was four cents better than expected. Total investment income was $22.8 million, up 66% year-over-year, which was $1.15 million better than estimates.
The increase in investment income was due to higher interest income, which was attributable to increases in the weighted average yield and weighted average principal balance of the company’s interest-bearing investments.
Click here to download our most recent Sure Analysis report on GLAD (preview of page 1 of 3 shown below):
BDC #2: TriplePoint Venture Growth BDC (TPVG)
5-year expected annual return: 17.8%
TriplePoint Venture Growth BDC Corp specializes in providing capital and guiding companies during their private growth stage, before they eventually IPO to the public markets.
TPVG offers debt financing to venture growth companies, proposing a less dilutive way to raise capital than raising additional equity while also helping with the businesses’ acceleration and expansion.
Source: Investor Presentation
On August 2nd, 2023, the company posted its Q2 results for the period ending June 30th, 2023. For the quarter, the company achieved a total investment income of $35.2 million compared to $27.4 million in Q2-2021. The increase in total investment was primarily due to a greater weighted average principal amount outstanding on its income-bearing debt investment portfolio and higher investment yields, partially offset by reduced loan prepayment activity.
Click here to download our most recent Sure Analysis report on TPVG (preview of page 1 of 3 shown below):
BDC #1: Oaktree Specialty Lending Corp. (OCSL)
5-year expected annual return: 22.0%
Oaktree Specialty Lending Corp. is a specialty finance company, or BDC. It provides lending services and invests in small and mid-sized companies.
As of June 30th, 2023, the investment portfolio accounted for $3.1 billion at fair value diversified across 165 portfolio companies, with a focus on software (18.2%) and pharmaceuticals (5.2%).
Source: Investor Presentation
On August 3rd, 2023, Oaktree Specialty Lending Corp. released its third quarter fiscal 2023 results for the period ending June 30th, 2023. For the quarter the company reported adjusted net investment income (NII) of $47.6 million or $0.62 per share, as compared with $45.4 million or $0.62 per share in the second quarter and $0.68 for the same quarter last year.
Click here to download our most recent Sure Analysis report on OCSL (preview of page 1 of 3 shown below):
Business Development Companies allow everyday retail investors the opportunity to invest indirectly in small and mid-size businesses. Previously, investment in early-stage or developing companies was restricted to accredited investors, through venture capital.
And, BDCs have obvious appeal for income investors. BDCs widely have high dividend yields above 5%, and many BDCs pay dividends every month instead of the more typical quarterly payment schedule.
Of course, investors should consider all of the unique characteristics, including but not limited to the tax implications of BDCs. Investors should also be aware of the risk factors associated with investing in BDCs, such as the use of leverage, interest rate risk, and default risk.
If investors understand the various implications and make the decision to invest in BDCs, the 5 individual stocks on this list could provide attractive total returns and dividends over the next several years.
At Sure Dividend, we often advocate for investing in companies with a high probability of increasing their dividends each and every year.
If that strategy appeals to you, it may be useful to browse through the following databases of dividend growth stocks:
The Dividend Aristocrats List: S&P 500 stocks with 25+ years of dividend increases.
The Dividend Kings List is even more exclusive than the Dividend Aristocrats. It is comprised of 50 stocks with 50+ years of consecutive dividend increases.
The Blue Chip Stocks List: stocks that qualify as Dividend Achievers, Dividend Aristocrats, and/or Dividend Kings
The High Dividend Stocks List: stocks that appeal to investors interested in the highest yields of 5% or more.
The Monthly Dividend Stocks List: stocks that pay dividends every month, for 12 dividend payments per year.
The Dividend Champions List: stocks that have increased their dividends for 25+ consecutive years.Note: Not all Dividend Champions are Dividend Aristocrats because Dividend Aristocrats have additional requirements like being in The S&P 500.
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