Some Dividends Are More Equal Than Others

Allied Capital (NYSE: ALD  ) has an illustrious history of success, but has been struggling mightily in the last few years to keep some semblance of business momentum. The business development company has been paying dividends to investors since 1963, and annualized with dividend reinvestment, those shares have returned 18% annually. That's the good news. The bad news is that since 2002, the dividends have stagnated, only growing from $2.20 to $2.42 in 2006. Contrast this with American Capital's (Nasdaq: ACAS  ) dividend growth over the same time frame -- from $2.57 in 2002 to $3.33 expected in 2006.

Allied Capital's results this quarter were still troubling. Net investment income excluding realized gains was flat year-over-year at $0.33 a share, yet the dividend payment was $0.62 a share. The difference has to be made up through portfolio exits and/or income carryovers, among other things -- not a particularly ideal situation for investors, as it raises questions about the sustainability of the dividend.

Furthermore, while management has been aware of this problem for some time, it has had difficultly fixing the issue. No doubt, poor growth in NAV (read: portfolio results) does not help -- it grew a pathetic $0.21 a share this quarter, to $19.38 from $19.17 year over year. Therefore, investors should be wary when viewing Allied's nearly 8% yield. While it is still the range that BDCs like Apollo Investment (Nasdaq: AINV  ) and Ares Capital (Nasdaq: ARCC  ) offer, its performance is far worse.

While BDCs like Allied and American have an excellent investing track record (American has historically had fewer charge-offs than traditional banks), investments still go sour. This is why Allied's investment in Krispy Kreme (NYSE: KKD  ) franchisee Sweet Traditions this quarter is somewhat concerning, as the doughnut maker certainly has a checkered history of failing to deliver for investors. One would hope that Allied's due diligence was particularly through in this case, as this investment looks to be a difficult work-out situation.

For Income Investor fans who seek dividend appreciation and have some appetite for risk, the BDC sector is worthy of further due diligence. This oft-maligned sector, which includes Rule Breakers pick Harris and Harris (Nasdaq: TINY  ) , has delivered some outstanding returns for shareholders.

For more BDC coverage at the Fool:

Krispy Kreme is a formerStock Advisorpick. To see which companies are currently making Tom and David Gardner's list, take a30-day free trial of the newsletter.

Fool contributor Stephen Ellis does not own shares in any companies mentioned. You canview the stocks he owns or check out his99th-percentile ranking in Motley FoolCAPS, the Fool's new stock-rating community. The Motley Fool has adisclosure policy.

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