In this piece, we will take a look at ten best BDC stocks to invest in.
Business Development Companies (BDCs) represent a compelling investment option for those looking to support smaller enterprises while earning a steady income through high dividend yields. BDCs operate as closed-end investment firms, specializing in providing much-needed capital to small and mid-size businesses that often face challenges accessing traditional sources of funding, such as bank loans or public equity markets. This unique business model allows BDCs to fill an essential gap in the financial ecosystem, supporting companies in various stages of development, including those undergoing turnarounds, experiencing financial distress, or poised for growth.
Established under the Investment Company Act of 1940, BDCs are required to meet specific regulatory standards, including maintaining registration with the Securities and Exchange Commission (SEC). What sets BDCs apart from private equity or venture capital firms is that they are publicly traded, giving regular investors access to an asset class that was once reserved for accredited or institutional investors. To qualify as a BDC, a company must allocate at least 70% of its assets to investments in privately-held or publicly-traded firms with market capitalizations below $250 million. This structure positions BDCs to invest in businesses that can benefit from their expertise and financial resources, generating returns for both the BDC and its investors.
One of the most attractive features of BDCs is their potential for generating income. Many BDCs offer dividend yields above 5%, with some even exceeding 10%. These high yields make them particularly appealing to income-focused investors. However, it’s important to approach BDC investments with careful due diligence, as high dividend yields can sometimes mask underlying financial issues. Investors need to ensure that a BDC’s portfolio and business fundamentals are strong enough to support consistent dividend payments without risking cuts in the future.
BDCs often rely on debt to finance their investments, which introduces leverage into their business models. This leverage can amplify returns during favorable economic conditions, allowing BDCs to maximize the value of their investments. However, leverage can also work against them during economic downturns, magnifying losses and putting pressure on their balance sheets. As a result, BDCs can be more volatile compared to other income-generating investments, particularly during periods of market turbulence.
Interest rates also play a significant role in the performance of BDCs. Since many BDCs borrow funds to invest, rising interest rates can increase their borrowing costs, potentially cutting into profits and reducing the overall returns to investors. Credit risk is another important factor to consider, as BDCs typically invest in smaller businesses that may be more vulnerable to financial instability or default. Analyzing the quality of a BDC’s portfolio and its risk management practices is crucial for investors looking to avoid excessive losses.
Tax considerations are another factor that makes BDCs unique. BDCs are required by law to distribute at least 90% of their taxable income to shareholders, which is why they often offer such high dividend yields. However, BDC dividends are not typically classified as “qualified dividends,” meaning they are taxed at ordinary income rates rather than the lower rates applicable to qualified dividends. For this reason, BDC investments may be better suited to tax-advantaged retirement accounts like IRAs or 401(k)s, where the tax impact can be minimized.
Despite these complexities, BDCs remain an attractive option for many investors, particularly those seeking high yields and exposure to a diverse range of smaller companies. For those willing to carefully evaluate the risks, BDCs offer the potential for both income and capital appreciation. In the following sections, we will highlight ten of the best BDC stocks to consider for your portfolio, analyzing their dividend yields, financial health, and overall investment potential. Whether you’re a seasoned income investor or new to BDCs, these stocks could provide valuable opportunities for steady returns in today’s market.
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Our Methodology
We sifted through online rankings and ETFs to come up with a preliminary list of 15 BDC stocks. We then examined Insider Monkey’s data on over 900 hedge funds, as of Q2 2024, and picked the 10 that were the most popular among elite hedge funds. The stocks are sorted in ascending order of the number of hedge funds that have stakes in them.
At Insider Monkey we are obsessed with the stocks that hedge funds pile into. The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
10. PennantPark Investment Corporation (NYSE:PNNT)
Number of Hedge Fund Holders: 4
PennantPark Investment Corporation (NYSE:PNNT) stands out as a compelling business development company (BDC) for investors. As a BDC, PennantPark Investment Corporation (NYSE:PNNT) specializes in providing mezzanine debt, senior secured loans, and equity investments to middle-market companies. The company’s portfolio spans diverse industries, including technology, healthcare, energy, and transportation, making it a key player in the private equity space. The stock is a promising candidate for inclusion in a list of top BDC stocks due to its diversified investment approach and focus on sectors poised for growth.
From a financial standpoint, PennantPark Investment Corporation (NYSE:PNNT) fundamentals paint a solid picture. In its Q3 2024 earnings call, the company reported GAAP net investment income (NII) of $0.24 per share, demonstrating its consistent ability to generate income from its investments. Core NII came in at $0.21 per share. Although there was a 2.2% decrease in NAV to $7.52 per share, this was primarily due to valuation adjustments on nonaccrual loans, which were partially offset by increases in equity investments. The company has consistently rewarded its shareholders with strong dividend payouts. For the quarter ended June 30, 2024, PennantPark Investment Corporation (NYSE:PNNT) issued a special dividend of $2.5 million from its joint venture (JV) portfolio. This highlights the company’s ability to not only generate income but also share it with investors. With a dividend yield of around 12%, PennantPark offers a lucrative income stream for shareholders, making it particularly appealing for income-focused investors.
PennantPark Investment Corporation (NYSE:PNNT) portfolio also boasts strong credit statistics. The weighted average yield on its debt investments was 12.7%, and the portfolio is composed of 56% first-lien secured debt. The company’s disciplined approach to investment, with a weighted average loan-to-value of 50% and interest coverage ratio of 2.0x, reflects its conservative strategy in managing risk while maximizing returns.
Overall, PennantPark Investment Corporation (NYSE:PNNT) is well-positioned for future growth, with a diversified portfolio, robust dividend yield, and strong investment metrics. Its focus on middle-market companies and strategic capital deployment makes it an attractive option for those seeking to invest in BDC stocks.
09. BlackRock TCP Capital Corp. (NASDAQ:TCPC)
Number of Hedge Fund Holders: 5
BlackRock TCP Capital Corp. (NASDAQ:TCPC) stands out as a strong option in the Business Development Company (BDC) sector, specializing in direct equity and debt investments across a wide range of industries. As a BDC, the company focuses on providing financial support to middle-market and small businesses, typically through debt securities, senior secured loans, mezzanine financing, and equity investments. Its diversified portfolio spans industries such as telecommunications, healthcare, technology, and energy, making it a well-rounded investment option in the BDC space.
One of the key highlights of BlackRock TCP Capital Corp. (NASDAQ:TCPC) is its focus on generating steady income for its investors, underpinned by its impressive dividend yield. For the second quarter of 2024, the company reported an adjusted net investment income (NII) of $0.38 per share, and its Board declared a third-quarter dividend of $0.34 per share. With a dividend yield exceeding 10%, BlackRock TCP Capital Corp. (NASDAQ:TCPC) demonstrates strong coverage, reflecting a disciplined approach to maintaining dividend stability. Over its 12-year history, the company has consistently covered its dividends with recurring NII, often paying special dividends as well.
In terms of financial performance, BlackRock TCP Capital Corp. (NASDAQ:TCPC) maintained a return on average equity of 14%, at the higher end of its historical range. The company successfully raised $325 million in fixed-rate unsecured debt at an attractive interest rate of 6.95%, showcasing its ability to capitalize on favorable market conditions. The company’s net leverage ratio of 1.13x is well within its target range, ensuring sufficient liquidity to navigate market volatility.
Despite challenges in the second quarter, such as a temporary increase in non-accrual status for certain portfolio companies, the overall portfolio health remains solid. The management’s active engagement with these companies to restructure their balance sheets suggests a path to recovery. With a focus on senior secured loans, which make up 91% of its portfolio, BlackRock TCP Capital Corp. (NASDAQ:TCPC) is well-positioned to continue delivering stable returns to its investors.
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