Prospect Capital (NASDAQ:PSEC) has certainly had a rocky 2014 so far.
After starting the year on a relatively high note, a series of negative events pushed the share price down by about 13% before it bounced back in June. But, after that rebound all the way back to about $11 per share, Prospect has fallen once again to roughly $10.20 per share.
So what happened, and is Prospect still worth buying?
An eventful year
First, Prospect and the rest of the business development company sector were removed from the S&P and Russell indices, creating tremendous downward pressure as index funds were forced to dump their shares.
Then, Prospect revealed it was in talks with the SEC involving some of the company's accounting practices. Although that turned out to be no big deal, it set off a flurry of threats of class action lawsuits, as well as the potential for reduced earnings in the future.
Finally, Prospect announced an increase in the use of its credit line, which led to uncertainty among investors.
Just when it looked like all of that was in the past, Prospect in late August reported an earnings miss that caused a significant drop in the share price.
The earnings miss itself isn't the primary cause for concern: Prospect posted $0.25 in earnings per share for the quarter, which was $0.07 less than the $0.32 that analysts expected. Revenue missed by almost 15%, and origination activity dropped significantly in the quarter, which led to a lot of questions from nervous investors during the company's conference call.
Specifically, the biggest concern for a lot of shareholders is Prospect's ability to continue paying its high monthly dividend, which is why many people invest in the company in the first place. Prospect generally declares its monthly dividends well in advance. For example, during the last quarterly report (in May), it declared the amount and dates of its dividends all the way to the end of the year. No such announcement was made this time, which led to investor speculation that a dividend cut might be on the horizon beyond December.
During the company's most recent conference call in late August, Prospect President Grier Eliasek said investors shouldn't read too much into the situation. Rather, since the company has already declared distributions through December, management has more time to digest market information over the coming months. And the company continues to have "spill back" income to use as a bank.
Whether a cut actually happens or not, the company has said it wants to fund the dividend with income, and not through a return of capital. However, the stock currently yields a little more than 13% per year and Prospect's portfolio yield has fallen to 12.1%, meaning one of three things is likely to happen. Either the company's income will improve by the end of the year, or Prospect will dip into its capital to keep the dividend high, or make a small reduction in the payout.
To buy or not to buy?
Despite the potential of a slight dividend reduction after December, Prospect looks like a pretty solid buy right now. The company currently trades at about a 5% discount to its net asset value of $10.56 per share, so even if the dividend ends up falling to say, 12%, you are still buying a pretty nice income-generating pool of assets at a discount.
My only reservation is that a dividend reduction could cause even more selling pressure and present a better buying opportunity in the future. However, the share price could rebound to its previous level just as easily if things turn around in the current quarter.
Overall, Prospect Capital still delivers a very compelling risk versus reward bet, and now you can buy it on sale.
Matthew Frankel owns shares of Prospect Capital. 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.