3 Reasons Why Fifth Street Finance Corporation Is An Unbeatable Income Investment

Fifth Street Finance Corporation is a highly diversified, high-yielding BDC trading at a discount to net asset value.

Jun 26, 2014 at 6:00AM

Fifth Street Finance Corporation (NASDAQ:FSC) has a highly diversified investment portfolio, trades at a discount to net asset value, provides investors with a double-digit dividend yield and pays its dividends on a monthly basis.

Fifth Street is one of the largest business development companies in the country lending to and investing in cash flow positive small and mid-sized companies. With a market capitalization of $1.3 billion, Fifth Street is the sixth largest business development company in the sector.

Business development companies invest in either debt or equity and their investment portfolios are usually heavily tilted toward debt investments. And Fifth Street is no different: The BDC has invested 83% of its funds in senior secured debt.

1. Discount to net asset value
Business development companies have to disclose their net asset value regularly in their public filings with the SEC. Similar to the reported book values of bank or insurance companies, the reported net asset values of BDCs allow investors to get a feel for a potential under- or overvaluation of the company in the marketplace.

Fifth Street, for instance, reported a net asset value of $9.81 per common share at the end of March 2014. With a current share price of around $9.50, the company trades at a discount of 3% to net asset value indicating that investors slightly undervalue Fifth Street.

2. Diversification across industries
One of the good things about Fifth Street is the relatively low risk profile of its investment portfolio compared to the high dividend yield the company offers investors. First, by concentrating on senior secured debt, Fifth Street plays the safest layer in the capital structure.

In addition, Fifth Street runs a diversified investment portfolio in terms of industry diversification. The BDC invests in a variety of industries ranging from Healthcare to IT Services and Oil & Gas Equipment.


Source: Fifth Street Investor Presentation

To add yet another layer of diversification, Fifth Street carefully controls its investment position sizes. Its biggest investment in the portfolio, a company called Desert NDT, LLC in the oil & gas sector, was valued at $133 million at the end of the second quarter, but accounted for just 4.8% of total assets. Its ten largest investments account for only 32.1% of total assets.

In total, Fifth Street has invested in 124 portfolio companies with a fair value of $2.8 billion.

3. High cash flow yield
A solid dividend yield goes a long way. Business development companies pay out most of their earnings to shareholders in order to minimize or avoid taxation on the corporate level.

Fifth Street currently pays investors $0.0833 per share in monthly dividends which equates to an approximately 10.5% annual dividend yield. Given the high degree of diversification in Fifth Street's investment portfolio and small position sizes, the BDC is an attractive income play for investors seeking recurring income.

Fifth Street also has a long record of cash distributions to shareholders which makes the company especially suitable as an investment for long-term oriented investors.

Moreover, the company pays its distributions monthly which has great value for shareholders. Monthly distributions allow investors to take advantage of a much larger set of reinvestment opportunities. Fifth Street also offers investors a Dividend Reinvestment Plan (DRIP) which always should be taken advantage of due to favorable reinvestment conditions (further information here).

The Foolish Bottom Line
Fifth Street is a highly diversified business development company offering a solid dividend yield of more than 10% to income investors. A long-track record in paying dividends and a discount to net asset value add to the attractiveness of Fifth Street.

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Kingkarn Amjaroen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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