Two Bets on BDCs for Growth and Income

05/17/2019 5:00 am EST


James Pearce

Director of Research, Investing Daily

Similar to a REIT, a business development company (BDC) is a type of regulated investment company that must distribute 90% of its net income to its shareholders, notes Jim Pearce, growth and income expert and editor of Investing Daily's Personal Finance.

However, unlike a REIT that invests in real estate, a BDC makes loans to small businesses in need of growth capital.

In March, I reviewed the two BDCs in our model portfolio and said, “Holding a few high-quality BDCs is a great way to increase the overall yield on your equity portfolio.”

Both of these companies recently released quarterly results that suggest the recent decline in economic growth is not yet having an impact on their operations as summarized below.

Hercules Capital (HTGC)

You have may have heard the name Hercules Capital in the news recently, but not in a good way. Two months ago, its founder and CEO was caught up in the college admissions scandal and was forced to resign from the company.

Its share price dropped 10% on the news, which I felt was a knee-jerk overreaction since the company was in no way involved in the lurid behavior of its leader.

The company’s board moved quickly to replace the CEO, and given its Q1 results it appears that the business did not miss a beat. Hercules recorded DNOI (distributable net operating income) of 34 cents per share, of which 32 cents will be paid out to shareholders as a dividend.

In addition, Hercules increased the size of its loan portfolio by 56% over the same quarter a year ago. That means there should be considerably more DNOI to distribute to shareholders as dividends in the years to come.

The day those results were made public (May 3), HTGC shot up more than 6%. As a result, it has made up nearly all of the loss over the past two months and is up 24% year-to-date.

Despite its recent run-up in value, Hercules pays a forward annual dividend yield of 9.5% that can be reinvested at no cost in more shares of HTGC via its distribution reinvestment program (“DRIP). Hercules can be bought up to $14.

Gladstone Capital (GLAD)

Our other BDC holding, Gladstone Capital released its Q2 results on May 1 came in as expected so its share price did not move. In fact, Gladstone’s share price hasn’t changed much over the past five years. But that’s okay so long as it keeps cranking out its generous dividend yield like bond payments.

During the most recent quarter, Gladstone’s net investment income was unchanged at 21 cents per common share, all of which was distributed to shareholders as a monthly dividend payment of 7 cents per share. That works out to a forward annual dividend yield of 8.9% at a recent share price of $9.50.

To compound that yield, Gladstone also offers a “DRIP” to its shareholders. And since it pays dividends monthly instead of quarterly, those payments grow at a faster rate than with most other DRIPs.

If you don’t need the money now, we suggest using the DRIP to accumulate shares that can later be converted to current income. Gladstone is a buy up to $10.

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