Risk-Takers Who Love Dividends Should Consider BDCs

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BDC’s, or Business Development Companies, provide a wide range of financial services, often to lower and middle market companies. Many of them charge fixed interest rates for services including debt and equity investments, or buyout transactions. It’s reasonable to think of these companies as similar to private equity firms.

While these businesses might not be familiar to all investors, they have qualities that should be appealing to nearly everybody. Specifically, many Business Development Companies trade for attractive multiples of their earnings and pay huge dividends to shareholders.

In an environment in which the stock market heads to new all-time highs and interest rates remain at historic lows, investors may be understandably searching for yield anywhere they can get it.

Three Business Development Companies to consider

Some of the big names in BDC’s that are publicly traded include Triangle Capital Corporation (NYSE: TCAP), Main Street Capital (NYSE: MAIN), and Prospect Capital Corporation (NASDAQ: PSEC).

Prospect and Main Street both carry market capitalizations in excess of $1 billion, while Triangle Capital is a small-cap in the space with a market value of $750 million.

Prospect Capital and Main Street are intriguing choices, not only because they have extremely high dividend yields, but they also pay their dividends monthly. Monthly dividend payments, instead of the traditional quarterly schedule, allow shareholders to compound their wealth over time even quicker, particularly for those investors who reinvest their dividends.

Prospect Capital raised its dividend at the end of 2012 by 8% and its current annualized distribution of $1.32 per share amounts to a more than 12% yield at recent prices. Main Street and Triangle Capital have robust dividends of their own, as each stock yields 6% and 7.5%, respectively.  Main Street recently raised its monthly payout by 3%, and Triangle Capital bumped up its last quarterly dividend by 2%.

Solid valuations to boot

Not only do these stocks pay huge dividend yields that handily beat the approximately 2% yield on the S&P 500, but they also happen to be trading for attractive valuations. Both Prospect Capital and Main Street trade for only 8 times their trailing twelve month earnings per share. Even Triangle Capital, which is the most expensive of the three, trades for only 12 times its trailing earnings.

In addition, each of these companies is reporting strong underlying financial performance to back up the investment case. Triangle Capital and Main Street reported full-year investment income rose 42% and 37%, respectively. Prospect is also seeing similar success with its own investment projects. Prospect’s total investment income more than doubled in its fiscal second quarter year over year.

The bottom line

These stocks are not for the faint of heart. After all, financial companies employ leverage to enhance their returns, which as we all learned the hard way during the financial crisis, is a double-edged sword.

Under adverse market conditions, you should fully expect these stocks to exhibit volatility in both their underlying performance as well as their dividend payments. However, it’s worth noting that the outsized dividend yields on these stocks are hard to resist in our current era of historically low interest rates. Bank products such as savings accounts and certificates of deposit pay little to no interest. Even higher-yielding traditional fixed income vehicles like bonds don’t offer compelling yields.

If you’re an investor interested in diversifying into the financial services industry and you don’t mind taking risks, these stocks may be worth further research. They each appear to be trading for modest valuations and offer huge dividend yields that are triple the current yield on the broader market.

Robert Ciura 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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