Top Dividend Stocks Among BDCs

Business development companies -- or BDCs -- will be marching in the earnings season parade next week.

Several of the high-yielding entities will be reporting next week, and income investors hungry for meaty payouts have been flocking to these top dividend stocks.

What makes BDCs so attractive? Well, let's start with the model. The typical BDC will provide financing to small- and medium-sized businesses that often can't line up conventional funding through major commercial banks. In return for taking on the risk, BDCs can ask for reasonably high interest payments and even some equity exposure. As long as they divvy up at least 90% of their interest income among their investors, there's no double taxation.

Risk is mitigated via diversification, but default rates are surprisingly low. A recent Barron's article claims that the annual loan-loss rate for BDCs is just 0.7%.

Here are some of the BDCs reporting next week.

 

Latest Quarter

EPS (Estimated)

Year-Ago

Quarter EPS

Yield

Prospect Capital (NASDAQ: PSEC  )

$0.30

$0.51

12%

TICC Capital (NASDAQ: TICC  )

$0.27

$0.27

11.4%

Ares Capital (NASDAQ: ARCC  )

$0.40

$0.38

8.9%

Fifth Street Finance (NASDAQ: FSC  )

$0.28

$0.28

10.5%

Main Street Capital (NYSE: MAIN  )

$0.49

$0.59

6.3%

 Source: Yahoo! Finance.

Don't make the mistake of merely hopping on the stock with the fattest yield. The top dividend stocks here aren't necessarily the ones with the best payouts. Many of these companies trade at premiums to their net asset values, and the beefy rates suggest that they're willing to take on bigger risks in chasing businesses that have no choice but to pay up. Keep an eye on the net asset value that each company will report next week. You don't want to pay too big of a premium, and naturally, you want to see net asset values clock in higher than they did at the end of last year.

It should also be problematic that just one of the five companies -- Ares Capital -- is expected to post year-over-year improvement on the bottom line. If earnings aren't growing, the hefty payout rates won't be sustainable.

There are some other nuances as investors sort through the list. Fifth Street Finance and Main Street Capital, for example, pay out monthly distributions instead of quarterly disbursements.

However, at a time when fixed-income rates are abysmal, and soaring REIT investments have driven those yields lower, it's easy to be drawn to the growing realm of BDCs. Know the risks. Know what you're buying. Know when the fundamentals turn.

BDCs are more than just pretty distribution checks.

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