These Three High Yielding Business Development Cos. Are Worth the Risk

Business Development Companies, commonly known as BDCs, make debt or equity investments in other companies, which cannot borrow funds though traditional banking. The BDCs earn high yields from their investments, which they can pass to their shareholders.

For investors in BDCs, the companies can offer above-average dividend yields. Nevertheless, because of the inherent risk of the BDCs’ investments, investors should perform due diligence. Here are three BDCs that offer exceptionally high dividend yields:

Goldman Sachs BDC: A Golden Opportunity

Goldman Sachs BDC (GSBD) 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 Corp. It now provides specialty finance lending to U.S.-based middle-market companies, which generate earnings before interest, taxes, depreciation, and amortization
in the range of $5 million-$200 million per year. The BDC usually makes investments between $10 million and $75 million, with a maturity between three and 10 years.

The investment advisor of Goldman Sachs BDC is Goldman Sachs’ very own Asset Management Team. As a result, Goldman Sachs BDC has much lower financing costs than most of its peers. This is a significant competitive advantage in this business, which is characterized by intense competition.

Goldman Sachs BDC has not been tested in a prolonged recession, but it proved markedly resilient throughout the coronavirus crisis. The company 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. During the last seven years, the company has grown its net investment income per share by 4.0% per year on average, with remarkable consistency. Furthermore, as the Fed has begun to raise interest rates aggressively, it may provide a tailwind to the investment income of Goldman Sachs BDC. Nevertheless, the BDC will have to keep its financing costs under control in order to benefit from rising interest rates.

Notably, Goldman Sachs BDC has paid the same annual dividend of $1.80 for eight consecutive years. At the current stock price, this dividend corresponds to an exceptionally high dividend yield of 12%. Given the healthy payout ratio of 90% and the reliable business performance of Goldman Sachs BDC, its dividend appears safe in the absence of a severe recession. Some investors will view the 90% payout ratio as too high. However, most BDCs have payout ratios near or above 100%, they have cut their dividend many times and have a much more volatile performance record than Goldman Sachs BDC. Overall, the dividend of Goldman Sachs BDC is one of the most attractive dividends in the BDC sector. Investors will be hard-pressed to identify a much more reliable BDC than Goldman Sachs BDC.

Capital Southwest: A New Direction

Based in Dallas, Capital Southwest Corporation (CSWC) is an internally managed investment company that has elected to be regulated as a BDC. The company 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. Media, marketing & entertainment, business services and consumer products & retail make up 11%, 11%, and 9% of the total value of the investment portfolio, respectively.

Since the spin-off of CSW Industrials in late 2015, Capital Southwest has managed to grow its net investment income per share every single year, at a fast clip, from $0.61 in 2017 to $1.90 in 2022. The stock is also offering an attractive dividend yield of 11.2%. The payout ratio is elevated, at 101%, but it is not extreme for a BDC and is much lower than it was in recent years. It is also worth noting that the payout ratio does not take into account the realized gains that are in the form of non-investment income.

As Capital Southwest took its current form only in 2015, it has not been tested in a severe recession. In the brief recession caused by the pandemic in 2020, the BDC proved resilient, as it grew its net investment income per share. Notably, Capital Southwest has grown its bottom line in each of the last six years. Given also its 8-year low price-to-earnings ratio of 8.9, the stock appears highly attractive right now.

Great Elm Capital: Under a (Too Tall?) Tree

Great Elm Capital is a BDC (GECC) that specializes in loan and mezzanine, middle market investments. It aims to create long-term shareholder value by building its business across three verticals: operating companies, investment management, and real estate. Great Elm Capital is primarily focused on investing in media, healthcare, telecommunication services, communications equipment, commercial services and supplies.

Unlike Goldman Sachs BDC and Capital Southwest, Great Elm Capital has exhibited a highly volatile performance record, even during normal economic periods. In the downturn caused by the pandemic in 2020, Great Elm Capital saw its earnings per share and its book value collapse. The BDC cut its dividend by 60% in 2021.

Great Elm Capital is currently offering an abnormally high dividend yield of 20.8%. This yield is enticing on the surface, but it comes with a high amount of risk. The payout ratio of Great Elm Capital is elevated, at 99%, though it is not extreme for a BDC. But due to its highly volatile performance record, its vulnerability to recessions and its weak balance sheet, Great Elm Capital is likely to cut its dividend significantly whenever the next downturn in its business shows up. To cut a long story short, Great Elm Capital is suitable only for speculators who have high risk tolerance and are well familiar with the risk of this BDC.

Because of the nature of the business, which involves investing in companies that cannot borrow funds from traditional banking channels, BDCs carry a greater risk than most stocks. With that said, Goldman Sachs BDC and Capital Southwest are currently offering double-digit dividend yields, with a decent margin of safety, especially the former. In the absence of a prolonged recession, those who purchase these two BDCs around their current prices are likely to be highly rewarded.