Gladstone Investment (GAIN): 2019 Top Picks' Mid-Year Update

07/22/2019 5:00 am EST

Focus: FINANCIALS

Adrian Day

Chairman and CEO, Adrian Day Asset Management

Adrian Day, editor of Global Analyst, selected Gladstone Investment (GAIN) as his more conservative investment idea for 2019. The stock rose 21% in the first half. Here's his latest update on this specialized financial firm.

Gladstone Investment is a Business Development Company (BDC), founded and chaired by David Gladstone who was a pioneer in the sector. BDCs lend money to small- and medium-sized businesses, and are structured as Registered Investment Companies.

Like the better-known REITs, there is no tax at the corporate level so long as virtually all of the net income is distributed to shareholders. Thus, yields tend to be high. BDCs vary in the level of risk they take, the size of investments, and in the sectors in which they invest. 

Gladstone focuses on relatively small businesses, usually lends with strong collateral, and takes equity as well as debt. Typically it invests in companies looking for funding to expand or, often, for a management buy-out. Gladstone does not invest in start-ups or turnarounds.  It is an active partner with its portfolio companies.

We bought Gladstone at year end at a somewhat depressed price, and it bounced back as high as $12/50 before retracing somewhat to the current $11.30.

BDC shares tend to be volatile, reacting to interest rate moves and developments in the economy, as well as news peculiar to the individual companies. So long as the dividend remains secure, we do not mind the stock volatility, but use it as opportunities to add to positions on weakness and occasionally trim on excessive strength.

In recent months, Gladstone has reported solid operating results and has been quite active, exiting four companies and buying into three new ones. The Net Asset Value has increased again, up to $12.40 (as of 3/31/19) from $10.85 a year ago.

In part, this was due to higher equity prices as the determination of carrying cost on its portfolio companies (independently, by S&P) takes broad market values into consideration.  In addition there were some very strong exits at higher than carrying cost.

One usual occurrence was the recent decision to retain a large portion of recent capital gains. The company paid tax on the gain and declared a deemed dividend. However, the positive is that this almost precludes the need for a secondary equity offering, and accompanying, dilution any time soon.

The company paid down its line of credit and still has sufficient cash (and even more available credit) for future investments. We would not like a BDC to do this too often, but in this case, in the circumstances, it makes good sense.

Right now, Gladstone is trading at only 90% on book, with a price to free cash flow multiple of only 4x, and a yield (including twice-annual supplemental distributions) of 8.5%. In today’s environment, a yield such as that, covered by earnings, with a solid balance sheet and potential to grow is rare indeed.  No wonder we have seen insider purchases in recent months.

If you bought in January, continue to hold; for new buyers, this is an attractive entry point.

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