What do you look for in a company? Earnings growth? Solid management? A juicy dividend? If you answered "All three," then I have something for you. There is a financial services company out there with high insider ownership and a bright future. Oh, and it has a dividend yield of more than 10%.
Before you get too excited, let me explain one thing about dividends. Some companies are mandated to pay out nearly all of their earnings in the form of distributions. So it's not that these companies just love you and want you to have their money, it's that they have to. Another note: A fat dividend yield does not always yield a good investment. If the company is issuing debt out the wazoo so it can give its investors a check every month, that's a red flag. If a company is not improving fundamentals and not investing in the future, that's a red flag. Income-oriented investors may love to see their investment pay off in guaranteed installments, but it's only guaranteed if the company continues to exist.
I'm being a Negative Nancy because I am presenting a company that is required to pay you almost everything that comes through the door, but it is also a great company with solid chances of capital appreciation.
Just tell me already
OK, OK, I'm sorry. It's Prospect Capital (NYS: PSEC) , guys. Prospect is technically a "business development company." If that means nothing to you, the best way to explain what Prospect does is that it's a private equity firm. Now hold on just a minute, stay with me! Prospect provides financing, restructuring, and, well, business development services to middle-market private companies. Prospect is not a buyout firm. Let me reiterate: Prospect is not a buyout firm. If the CEO of Prospect ran for president, you couldn't accuse him of being an evil billionaire. Though I suppose it is possible he drove around with his dog on top of his car.
Prospect used to focus mainly on financing energy companies. As we all know, energy and utility companies require an incredible amount of up-front financing to do whatever it is that they do. It was a good business to be in for Prospect, though the stock price floundered for nearly a decade. If you had bought Prospect in 2004, when it IPO'd, you'd be down around 20%. But wait, don't forget about the huge dividend. With dividends included, you'd have a much nicer return of around 70%. Now, an annualized return of about 7% is not phenomenal, but think about what the company went through:
It IPO'd. IPOs already suck, but to add to it, financial services IPOs tend to suck even more. It usually takes around two years for an IPO to start behaving like a real stock.
2007-2009 happened. 'Nuff said.
Since then, the company has made a slow but steady recovery in stock price. The one-year return on the company, including dividends, is over 30%. So what has spurred the capital appreciation? Well, the company decided to diversify away from being an energy financier. Prospect has interests, whether direct investments or loans, in companies ranging from metal manufacturers to property management firms. The company's investment revenues are on the rise, and management thinks there is more to come.
I'm not the only one looking to pick up some Prospect. The company's executives are share-hunting as well. As Peter Lynch famously said, and I am paraphrasing here, there are a thousand reasons for management to sell, but only one reason for them to buy. The CEO, the COO, and directors have been buying hundreds of thousands of shares since last year -- when the company was trading around $8.50. The stock price has appreciated to the low 11s now, but we haven't seen any selling going on.
If you take a look at the most recent quarterly report, the company states that its strategy is to engage in long-term investments that create long-term value. If you're going to invest in a private equity company, you want one that carries on long-term relationships with its clients, not fast deals to make a quick buck.
Do you think I'm off-base? Sound off in the comments section below!
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At the time thisarticle was published Fool contributorMichael Lewisowns none of the stocks mentioned. You can follow him on Twitter@mikeylewy. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.
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