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2 Aggressive Investments in Business Development Companies

The BDC business model is to lend to small and midsized companies at high yield equivalent rates while also at times taking equity stakes in such companies.  BDCs can also take an active part in assessing the borrower’s prospects and modifying business practices if necessary with the goal of ensuring a favorable
return for shareholders and principals in the company.  The combination of making loans and taking equity stakes has the potential for relatively high, stable cash distributions with the additional benefit of capitalizing on the equity performance of the borrower.

Now, BDCs are offered as bundles in ETNs that come as a normal ETN (BDCS) and a 2X leveraged ETN (BDCL) for aggressive investors.

The ETRACS Linked to the Wells Fargo Business Development Company Index due April 26, 2041 (BDCS) is designed to track an investment in the Wells Fargo Business Development Company Index, and may pay a variable quarterly coupon linked to the cash distributions associated with the underlying BDC constituents, less investor fees.  BDCS is trading at $22.34 with a quarterly dividend yield of 9.78%.  Year to date, BDCS has a market return of 12.5% compared to 9.5% for the S&P 500.  Here are the top holdings:

ACAS     American Capital Ltd

ARCC     Ares Capital Corp

SUNS     Solar Senior Capital Ltd

AINV     Apollo Investment Corp

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FSC         Fifth Street Finance Corp

TAXI       Medallion Financial Corp

BKCC     Blackrock Kelso Capital Corp

SLRC      Solar Capital Ltd

HTGC     Hercules Technology Growth Capital Inc

MCC      Medley Capital Corp

For the most aggressive investors, the ETRACS 2xLeveraged Long Wells Fargo Business Development Company Index (BDCL) is designed to track a leveraged investment in the Wells Fargo Business Development Company Index and pay a variable quarterly coupon linked to the leveraged cash distributions associated with the underlying Business Development Company (“BDC”) constituents, less financing costs and investor fees.  BDCL is trading at $20.65 with a dividend yield of 16%% based on its most recent quarterly distribution of $0.8197 in January 2012.  Year to date, BDCL has a market return of 24.81% compared to 9.5% for the S&P 500.  The portfolio is like BDCS except the ETF is leveraged 2 times.

High Yield Stocks with Growing Dividends that are Overpriced

My model for performing the intrinsic and future values are shown in the table below using three stocks that are trading at a premium or discount
to their fair value.  By using the average PE ratio and projected EPS growth, you can use the future time value formula to get an estimate of earnings X number of years into the future. Once you have the future projected earnings per share, just multiply by the PE ratio to get a future stock price. All of the projected growth rates are available on most websites providing detailed stock information. This is great information when looking at the future of a stock in comparative terms. Take this one step further, and you can determine the intrinsic value of a stock. Here, you are using the present time value formula based on your required rate of return. The end result is having a fair value estimate of the stock to compare to the stock’s current trading price. This comparison will determine if a stock is overvalued or trading at a discount.

We use the same concept to determine the future dividend payout and yield in future years.  For me, I prefer to project 10 years forward based on past compound annual growth rates [CAPG] of 10 years of data. The number of years can be adjusted for shorter time periods for stocks with less than 10 years of public data. What should your required rate of return be?  I am currently using a 10% return on invested capital.  Here is my assessment of three high yield
stocks.

Altria Group (MO) engages in the manufacture and sale of cigarettes, smokeless products, and wine in the United States and internationally.  Currently, MO is trading at a 17% premium to its fair value.  It has an EPS growth rate of 8%, with an average PE of 13.4. MO is projected to have a future dividend yield
of 5.5%, but its dividend yield on cost is projected to be 12% in 10 years.  This is an excellent investment to buy as a dividend grower especially on a pullback to its fair value of $25.

AT&T Inc., (T) provides telecommunication services to consumers, businesses, and other service providers worldwide.  Currently, T is trading at a 39% premium to its fair value.  It has an EPS growth rate of 3.7%, with an average PE of 14. T is projected to have a future dividend yield of 5.7%, but its dividend yield on cost is projected to be 8.9% in 10 years.  AT&T is overpriced for such a low growing stock but is a stable dividend payer.

Holly Energy Partners, L.P. (HEP) operates a system of petroleum product and crude oil pipelines, storage tanks, distribution terminals, and loading rack facilities.  HEP is trading at a 20% premium to its fair value.  It has an EPS growth rate of 6.7%, with an average PE of 21. HEP is projected to have a future dividend yield of 4.7%, but its dividend yield on cost is projected to be 9.7% in 10 years.  Investors should be cautious as HEP has a payout over 100% of EPS.

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