Image Source: Unsplash
 

Income-oriented investors continuously try to identify stocks that will offer them generous income streams. Business Development Companies, commonly known as BDCs, are attractive candidates for the portfolios of income-oriented investors. BDCs make debt or equity investments in other companies, which cannot access funds via traditional banking channels. Due to their inability to borrow funds via traditional channels, the customers of BDCs offer high yields on the investments of BDCs. As a result, BDCs offer exceptionally generous dividends to their shareholders and hence they are great candidates for income-oriented investors. Nevertheless, due to the inherent risk of investments in BDCs, investors should carefully analyze a BDC before investing in it. In this article, we will discuss the prospects of three BDCs that are offering exceptionally high dividend yields right now.
 

Goldman Sachs BDC (GSBD)

Goldman Sachs BDC is a closed-end management investment company that has elected to be regulated as a BDC. It became public in 2015 and is based in New York. In 2020, the company merged with Goldman Sachs Middle Market Lending Corporation. It now provides specialty finance lending to U.S.-based middle-market companies, which generate EBITDA in the range of $5-$200 million per year. Goldman Sachs BDC usually makes investments between $10 million and $75 million, with a maturity of 3-10 years.

The BDC sector is characterized by intense competition, with most companies lacking a meaningful competitive advantage. Goldman Sachs BDC is a bright exception to the rule, as it has a significant competitive advantage. The investment advisor of Goldman Sachs BDC is Goldman Sachs’ very own Asset Management Team. As a result, Goldman Sachs BDC enjoys much lower financing costs than most of its peers.

As Goldman Sachs BDC became public just eight years ago, it has not been tested in a prolonged recession, such as the Great Recession. Nevertheless, the company proved markedly resilient throughout the coronavirus crisis. Most BDCs incurred a sharp decrease in their net investment income and cut their dividends in that crisis. On the contrary, Goldman Sachs BDC grew its net investment income per share in both 2020 and 2021 and maintained its generous dividend.

Moreover, Goldman Sachs BDC has exhibited a much more consistent performance record than the vast majority of BDCs, which have posted highly volatile results. During the last eight years, Goldman Sachs BDC has grown its net investment income per share by only 2.7% per year on average but with remarkable consistency.

Goldman Sachs BDC has paid the same annual dividend of $1.80 for eight consecutive years. The absence of dividend growth may disappoint some investors but the dividend of Goldman Sachs BDC is highly attractive. The stock is currently offering a nearly 8-year high dividend yield of 13.3%, with a payout ratio of 84%. While the payout ratio may seem high to most investors, it is decent for a BDC. Most BDCs have payout ratios near or above 100% and have cut their dividends at least once over the last decade. Given the reliable performance of Goldman Sachs BDC, its dividend is one of the most attractive dividends in the BDC sector.
 

Ares Capital Corporation (ARCC)

Ares Capital Corporation is a US-based closed-ended specialty finance BDC. It focuses on generating both current income and capital appreciation through debt and equity investments. The company invests primarily in U.S. middle-market companies as well as larger companies.

Ares Capital is one of the highest-quality BDCs, as it is the only one with investment-grade ratings from the three major credit rating firms. In addition, the company has a healthy balance sheet, with high asset quality and a diversified long-duration liability structure. Ares Capital also has diversified holdings, with weighted average interest coverage of over 2 times, thus minimizing default risk.

Thanks to its high-quality investment portfolio, Ares Capital has exhibited a much less volatile performance record than the vast majority of BDCs. The company has grown its earnings per share by only 1.1% per year on average over the last nine years, but with much more consistency than a typical BDC.

Moreover, Ares Capital has not cut its dividend over the last decade. It has frozen its dividend for some years but it has grown its dividend over the long run. It is one of the few BDCs that did not cut their dividends during the pandemic. The stock is currently offering a nearly 10-year high dividend yield of 10.7%, with a reasonable payout ratio (for a BDC) of 82%. Thanks to the strong business model of Ares Capital, its dividend is safe in the absence of a prolonged recession.
 

Capital Southwest Corporation (CSWC)

Capital Southwest Corporation is an internally managed investment company that has elected to be regulated as a BDC. The company is based in Dallas and has expertise in providing debt and equity financing to lower-middle-market companies and debt capital to upper-middle-market companies located primarily in the U.S.

The credit portfolio of Capital Southwest, which consists of 78 lower and upper-middle-market companies, has a decent yield on debt of 10.6%. The investment portfolio of the BDC is well-diversified, with exposure to nearly 25 industries.

Capital Southwest has proved markedly resilient throughout the coronavirus crisis. Despite the fierce recession caused by the pandemic in 2020, the BDC kept growing its earnings per share in 2020, 2021, and 2022.

Moreover, Capital Southwest is currently offering a nearly 9-year high dividend yield of 12.1%. Its payout ratio is too high, standing at 99%, but it is somewhat misleading, as the earnings of the company do not include the realized gains that are in the form of non-investment income. Given its resilience during the pandemic and its consistent growth record, Capital Southwest appears highly attractive around its current stock price.
 

Final Thoughts

In principle, BDCs have a higher inherent risk than most companies due to the nature of their business, which involves investing in companies that cannot borrow funds via traditional banking channels. Therefore, investors should carefully examine a BDC before investing in it. The above three BDCs are among the highest-quality companies in the sector and are attractively valued right now. As a result, they are likely to highly reward income-oriented investors with a long-term perspective.

More By This Author:

Monthly Dividend Stock In Focus: Chesswood Group
Monthly Dividend Stock In Focus: First National Financial Corporation
Monthly Dividend Stock In Focus: Mullen Group