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The Best Dividend Opportunity You've Never Heard Of

By Dan Caplinger - Updated Apr 6, 2017 at 9:25PM

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Business development companies can be a great investment.

One of the biggest challenges investors face these days is getting enough income from their portfolios. In that quest, many people have had to uncover a wide variety of previously unknown types of investments in order to get the most from their money.

Even with the big increase in popularity of some pretty esoteric dividend stocks, one class of investments remains largely untapped. But as more investors realize both the healthy dividends and growth potential of these investments, I don't think they'll stay under the radar too much longer. Below, I'll reveal some of these investments, and explain why they're different from the run-of-the-mill dividend stock.

Getting into some weird stuff
Until recently, most dividend investors stuck with pretty basic choices. Utilities and financial stocks (believe it or not) used to be tried-and-true sources of income; they didn't give you much growth, but you could count on getting a check every quarter.

With the financial crisis, though, we all know what happened with financial stocks. And while utility stocks still pay decent dividends, low interest rates have decimated the amount of income investors get from bonds, bank CDs, and other fixed-income investments. That has forced some of them to reach for greater yields.

That, in turn, has pushed interest in mortgage REITs like Annaly Capital and master limited partnerships such as Enterprise Products Partners. Once almost unknown, these investments are now almost household names among those who follow dividend stocks.

Another type of high-yielding investment is the business development company. Although BDCs haven't gotten as much attention as mortgage REITs and MLPs, their yields merit attention.

What's a BDC?
Business development companies occupy an interesting niche in the investment world. They trade as public companies, but they are largely conduits to make long-term private investments. For instance, American Capital (Nasdaq: ACAS) -- not to be confused with mortgage REIT American Capital Agency -- has a diverse portfolio of private investments in a range of companies. Its holdings include the makers of advanced medical devices and aerospace components for jet engines, the nation's oldest candy company, and the maker of Rug Doctor steam carpet cleaners.

You may not think that private investments necessarily generate much income. After all, private equity firms typically only cash in once their private investments have IPOs or get acquired, resulting in very lumpy income streams.

But because of the way BDCs are set up, they're required to distribute income to their shareholders as they earn it. In many cases, that results in some really high yields. Take a look at the current dividend yields of these BDCs:


Dividend Yield

Sample Investment

Apollo Investment (Nasdaq: AINV) 10.4% General Nutrition Center
Ares Capital (Nasdaq: ARCC) 8.2% Apple & Eve juice maker
Prospect Capital (Nasdaq: PSEC) 10.7% Retailer Deb Shops
TICC Capital (Nasdaq: TICC) 9.9% NetQuote insurance portal
NGP Capital (Nasdaq: NGPC) 8.8% ATP Oil & Gas
MCG Capital (Nasdaq: MCGC) 10.7% For-profit educator Stratford School Holdings

Sources: Yahoo! Finance and company websites.

As you can see, these dividends put BDCs among the top-yielding investments you can buy. And because of their investments in up-and-coming businesses, some of them also have substantial potential for capital appreciation as well.

Watch out
That said, anyone who says that BDCs are free-money investments is lying to you. Because BDCs typically invest in companies that don't have the same access to capital markets that publicly traded companies do, those investments are inherently riskier.

In addition, unlike some other high-dividend investment categories, BDCs are very different from one another. Whereas one mortgage REIT's portfolio may well look almost identical to another's, BDCs have very different focus areas they concentrate on, which can lead to vastly different investment results over the long run. You can see that from the fact that American Capital doesn't pay a dividend currently. In addition, one BDC, Allied Capital, had to be rescued by Ares Capital in 2010 after commercial real estate and equity investments went bad.

Get paid
Even with the risks involved, business development companies aren't something you want to ignore. They take a little more work to understand, but their unique combination of income and high-growth potential is something you won't see in many high-yielding investments.

If you're looking to draw more income from your portfolio, don't miss out on these stocks. Click here to get the names of 13 high-yielding stocks that Motley Fool analysts believe belong in your portfolio.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.

Fool contributor Dan Caplinger likes discovering off-the-beaten-path investments. He doesn't own shares of the companies mentioned in this article. 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. You'll hear a lot about The Fool's disclosure policy.

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Stocks Mentioned

Apollo Investment Corporation Stock Quote
Apollo Investment Corporation
$13.43 (0.52%) $0.07
Ares Capital Corporation Stock Quote
Ares Capital Corporation
$20.70 (1.27%) $0.26
Prospect Capital Corporation Stock Quote
Prospect Capital Corporation
$8.18 (0.37%) $0.03
OHA Investment Corporation Stock Quote
OHA Investment Corporation

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