Business Development Company Stocks

The stock market melted up in April and May nearly as quickly as it melted down in February and March. The injection of trillions of dollars of liquidity into the capital markets certainly helped, but if you’re a value investor, the sheer speed of the move has to be a little concerning.

As I mentioned last week, even the great Warren Buffett missed the opportunity to buy the dip and has been sitting on a mountain of cash with nothing attractive to spend it on.

But if you’re willing to look a little outside of the mainstream, opportunities do still exist. And one of the most attractive sectors at the moment is in business development company stocks, or BDCs.

Income investing is a big part of what I do, and business development company stocks are some of the highest-yielding equities you’ll generally ever find.

Like REITs — which I highlighted early last month — business development company stocks benefit from preferential tax treatment. They pay no corporate income taxes so long as they pay out at least 90% of their net income as dividends.

You can think of business development company stocks as private equity companies for regular, everyday investors. As with private equity companies, BDCs make debt and equity investments primarily in established companies, though most BDCs focus on “middle market” companies that are often a little too small for the big boys in private equity.

BDC managers are generally more than just passive investors. They actively guide their portfolio companies, taking an active role in high-level decisions.

The biggest practical difference between business development company stocks and private equity is liquidity. BDCs trade actively on the New York Stock Exchange, whereas private equity funds are of course private and often have lockup periods of seven years or more. If you’re unhappy with a BDC, you can always dump it and move on, just like any other stock.

All About the Yield

Now let’s talk everyone’s favorite subject: income.

While most income-oriented securities have enjoyed rallies over the past two months, business development company stocks remain cheap. A big part of this is the influence of the Fed. The Federal Reserve made it very clear it will be gobbling up as many bonds as it can find in order to stabilize the capital markets.

This encouraged portfolio managers to (legally) front run the Fed by buying up the bonds that the central bank had telegraphed it would buy.

Business development company stocks didn’t have that benefit, and their investors tend to be individual mom-and-pop investors looking for yield.

That’s not a bad thing. This lack of institutional buying is exactly why the opportunities exist today.

Let’s look at a few examples.

Ares Capital Corp. (NYSE: ARCC) is the largest business development company stock by market cap. At today’s prices, the company yields a whopping 12.1%.

Main Street Capital (NYSE: MAIN) is another BDC particularly popular with retirees because it pays is dividends monthly, rather than quarterly. At current prices, it yields a competitive 9.2%.

BDC dividends are not the same as bond interest, of course.

BDCs can and do regularly raise or lower their dividends to match their cash flows. Some BDCs will have to lower their dividends in the quarters ahead as the coronavirus lockdowns have slammed some of their underlying portfolio companies. But even if the sector slashed its dividends in half — which isn’t realistic — it would still be one of the best yield plays available today.

• Money & Markets contributor Charles Sizemore specializes in income and retirement topics, and is a frequent guest on CNBC, Bloomberg and Fox Business.

Follow Charles on Twitter @CharlesSizemore