What: Shares of Prospect Capital (NASDAQ:PSEC), a business development company that lends to, and invests in, private businesses, tumbled 11% in December, based on data from S&P Capital IQ. The change came on the heels of an update on Prospect Capital's at-the-market equity issuance program and announcing its dividend payments for February, March, and April.
So what: According to Prospect Capital's Dec. 8 press release, it plans to suspend all at-the-market equity issuances for the foreseeable future due to the company's increased focus on higher earnings quality and less risk. Generally speaking, safer investments have lower yields, while higher yields accompany riskier investments. In return for its shrinking yield, Prospect Capital is taking an approach that should result in minimal volatility in the near-term.
The downside of playing it safe is that Prospect Capital announced its monthly dividend payment between Feb. and April will be just $0.08333 cents per share, down from the $0.111 cents per share it had been paying. As Chairman and CEO John Barry III commented in the press release,
"We have not chased higher yields that we believe do not compensate for risk. While we have more than covered our prior dividends out of taxable earnings, we are reducing the next three declared dividends from past levels because we believe we should pay a dividend that is no more than the minimum expected net investment income, based on our expectations over the next twelve months."
Now what: Make no mistake about it, investors are devastated by the dividend cut. Still, even after the cut, Prospect Capital is on pace to pay $1 in extrapolated payouts assuming no additional change to the dividend. That still equals a substantial 12% yield!
Ultimately I believe this was a smart and necessary move for Prospect Capital considering how weak small-cap stocks and small businesses in general have performed relative to the market. Accepting lower yields now isn't necessarily a bad thing as it could put Prospect Capital in an advantageous position if 2015 turns out to be more like 2008 than 1999. It's not out of the question that the company will cut its payout again, but I feel relatively confident that its payout will maintain at least the 10% yield level.
If I were an income investor willing to accept moderate levels of risk, I'd consider giving Prospect Capital a close look right here.