Is Prospect Capital's CFO Telling You to Buy?

Famed money manager Peter Lynch told us executives can sell their stock for any reason, but typically buy only for one: They think the price is going to go up!

Today I'm highlighting financial services specialist Prospect Capital (Nasdaq: PSEC  ) , which saw its CFO buy some $275,000 worth of stock over the past week even though shares have climbed more than 35% in 2012. These aren't option grants, but rather purchases made on the open market just like you and me.

Prospect Capital Snapshot

Market Cap $1.9 billion
Revenues, TTM $321 million
1-Yr. Stock Return 54.4%
Return on Investment 10.9%
Est. 5-Yr. EPS Growth 5%
Dividend & Yield $1.22 / 10.5%
Recent Price $11.66
CAPS Rating *****

Source: FinViz.com.

Although following the lead of insiders can be profitable, I still recommend you do further due diligence to determine whether this stock would make a good addition to your own portfolio. So this isn't a call to buy, but just the inside track on a company you might want to check out further.

Putting your money where your mouth is
I particularly like it when a CFO buys stock in his company. If there's anyone in the business that understands how well it's running -- arguably even more so than the CEO -- it's the top finance guy. When I see him buying shares, I'm reminded of CNS, the maker of Breathe Right nasal strips, which saw its CFO begin buying company stock after it was beaten down and then continue doing so over a period of months. When that quarter's results came out, profits had tripled, and the stock jumped 12% in one day. It wasn't long before GlaxoSmithKline bought out CNS.

Prospect Capital might not be the target of anyone's takeover ambitions, but my ears perk up when I hear the CFO thinks the stock is ready to go higher still.

A taxing decision
The financier primarily lends money to and invests in middle-market privately held companies as well as those that are public but thinly traded. It's opted to be treated as a business development company for tax purposes, meaning they pass on most of their income to investors. They get to avoid paying federal income taxes as a result and their payouts to shareholders are treated as ordinary income.

Consider BDCs to be publicly traded private equity firms and you'll find they have been doing well this year, targeting investment into companies with better than average prospects for growth. Since they're not required to limit themselves to just publicly traded stocks, BDCs can find the best investments around. Industry peers MCG Capital (Nasdaq: MCGC  ) and Apollo Investment (NYSE: AINV  ) have also enjoyed their shares matching Prospect's gain in 2012 while American Capital (Nasdaq: ACAS  ) is up almost 70% so far this year.

Lend me your ear
Lending to small businesses by traditional banking institutions has not lived up to the big, splashy announcement they made last year with the largest U.S. banks committing to Vice President Biden $20 billion in new loans to small businesses over the next three years. In looking at FDIC data, analysts at MultiFunding found that while some banks like JPMorgan Chase, Citibank, and PNC had increased their lending over the prior year, others like Wells Fargo and Bank of America (NYSE: BAC  ) had actually scaled back their lending efforts. As a matter of fact, the aggregate total of lending for the 13 banks present at the press conference actually declined by more than $2 billion over the last 12 months.

That's a prime reason alternative sources of financing like BDCs are succeeding. They're stepping into the void created by the lack of bank commitment. When Prospect Capital reported fourth-quarter results last month, it ended up beating Wall Street earning estimates by $0.12 per share and came in above revenue forecasts, too, as net investment income nearly doubled. Guidance was also upbeat and ahead of the consensus.

I've gone and rated the BDC to outperform the broad market indexes on Motley Fool CAPS, but you can tell me in the comments box below whether you agree the CFO of Prospect Capital is giving investors a green flag to join the race higher.

On the inside track
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Fool contributor Rich Duprey holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Wells Fargo, PNC Financial Services, Bank of America, JPMorgan Chase, and Citigroup. Motley Fool newsletter services have recommended buying shares of Wells Fargo. The Motley Fool has a disclosure policy.
We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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