Newtek Business Services (NEWT) remains one of our favorite Business Development Companies (BDCs); despite recent weakness, the stock is still up 84% so far in 2021, notess Rida Morwa, editor of High Dividend Opportunities.
There are many misperceptions about NEWT because their business model is different from most BDCs. Generally, BDCs make debt investments and then hold them to maturity. NEWT primarily profits from the origination of loans, which are then sold, with NEWT maintaining only a small portion.
Newtek is currently the largest non-bank lender licensed by the SBA under the federal Section 7(a) loan program by annual origination volume. These are loans made to help small businesses by the Small Business Administration. In addition, 70%-75% of the loan is guaranteed by the SBA.
Much of NEWT's NAV is tied up in a series of companies that provide services to small businesses. Where BDCs typically have only a very small equity position in their portfolio companies, NEWT owns a controlling stake in several of theirs.
Instead of solely being "portfolio companies", these businesses serve as operating subsidiaries of NEWT, designed to provide leads for the lending business. In other words, they are an active part of NEWT, as opposed to passive equity investments we see with most BDCs.
The result is that the NAV that some rely on for valuing BDCs is not a reliable method to value NEWT. Instead, the best way to value NEWT is by the cash flow that it can produce for itself and distribute to shareholders through dividends. By that measure, NEWT is very cheap.
Unlike many other BDCs, NEWT will vary its dividend quarter to quarter to match their taxable income. So when NEWT pays their dividend, you know it is always covered by taxable income.
In short, NEWT is paying precisely the perfect dividend because they wait until after they have earned the income to decide what the dividend will be. As a result, they are never overpaying, and they are never underpaying.
The best part is that insiders own about 7% of the company. That, combined with their dividend policy of paying out 100% of taxable income, means that management is extremely well aligned with investors.
The best way to value NEWT is by the income it is capable of producing. This year, NEWT will produce $3.00 to $3.30 per share in dividend income for investors. This means that NEWT's yield over the next 12 months will likely be more than 8.7%.
When we consider the growth outlook for NEWT, that is just a starting point, as we can expect NEWT's portfolio companies to continue growing. When NEWT drops, we are ecstatic to be buying the dip!