Taking Stock: Business development companies

Dear Mr. Berko:
On several occasions, you have mentioned business development companies and praised their high yields. Please tell me what a business development company is and how it works. I have $30,000 to invest if you think they are good. So please recommend three or four with yields higher than 10 percent.
W.E., Joliet, Ill.
   
Dear W.E.:
A business development company is usually a publicly traded equity registered under the Investment Company Act of 1940. They are configured similarly to real estate investment trusts in that a BDC must pass on 90 percent of its income to shareholders so that most of it will be taxable to the investor. 

BDC management invests in small upcoming businesses expecting the value of their investments to grow in worth. BDCs are very important lenders to small enterprises and often provide consulting services on a fee basis. 

So when managements make a loan or investment, they seek an enterprise in which they can influence the company’s direction via a consulting contract and by appointing board members. BDCs cannot invest more than 5 percent of their assets in one company; they can’t own more than 10 percent of any issuer’s voting stock and can’t invest more than 25 percent of their assets in businesses that are in the same industry.

Today, BDCs are making good loans when many banks either can’t or won’t. And today’s credit crunch has made it difficult for many small and midsize companies to secure capital. So BDCs have found a potentially rich source of good investment options, which is a bonus for small businesses and investors who seek higher yields with a potential for capital appreciation. 

As regional banks continue to zipper their purses, more and more small and midsize companies are turning to publicly traded BDCs, and some have become very attractive (with varying degrees of risk) investments. Many BDCs have rallied from their market lows, but the very real possibility of a double-dip recession would create a difficult environment for these companies. 

With their various degrees of risk and yields of 10 percent to 12 percent, the following BDCs can be bought by investors who can assume more than a modest degree of risk.

PennantPark Investment (PNNT — $10) earned $1.08 last year, and the Street expects earnings of $1.11 this year and $1.22 in 2011. The $1.04 dividend yields 10.4 percent. SunTrust and Ladenburg Thalmann have “buy” recommendations with a 12-month price target of $15. 

Apollo (AINV — $10) earned $1.65 last year, but the Street expects lower earnings of $1.10 for 2010 and $1.18 for 2011. Still, it’s an attractive buy, with a dividend of $1.12 that yields 11.1 percent. Wells Fargo rates AINV as “outperform,” and Ladenburg Thalmann tells us it’s a “buy” with a $13 price target. 

Finally, Ares Capital (ARCC — $14.25), which earned $1.31 last year, expects earnings of $1.29 in 2010 and $1.52 next year. It’s recommended by JMP Securities, SunTrust and Ladenburg Thalmann with a price target of $18.50. The $1.40 dividend, which will probably be raised, yields 10.1 percent. 

But don’t drop the entire caboodle — just invest half now and wait a few months to see if the Dow decides to test the 8,000 to 8,500 level. If it does, then drop the other half.

Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775 or e-mail him at mjberko@yahoo.com. Visit Creators Syndicate Web site at www.creators.com.
© 2010 Creators Syndicate Inc.