The song remains the same, and it will for the foreseeable future. The Federal Reserve probably will not raise rates until 2023, so we remain in a setting with coupons on government securities still close to generational lows. Certificates of deposit at banks are wretched, with the best five-year rate we could find at a paltry 1.25%. Quality investment-grade corporate and municipal bonds? Same story.
So what are balanced growth and income investors to do? The potential for capital appreciation on low-coupon bonds is negligible, and with the market possibly primed for a big sell-off, risking high-yield or leveraged funds doesn’t make any sense for those with low risk tolerance. What does make sense is looking at the business development stocks that pay outsized dividends and offer growth potential.
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Business development companies are organizations that invest in small and medium-sized companies, as well as distressed companies. These so-called BDCs help the small and medium-sized firms grow in the initial stages of their development. With distressed businesses, the BDC helps the companies regain sound financial footing.
A new Truist Securities research report features a deep dive into BDCs, and the firm is reasonably positive on the group going forward. While the stocks are better suited for investors with a larger risk tolerance, the income generated can be well worth it. The report said this:
We anticipate 2021 could be the best new origination pricing environment since the end of the 2008 financial crisis, but have concerns regarding the state of the economy and loan activity. That said, we believe conditions are ripe for BDCs with scale, size and financial capacity to fuel investment growth through 2021. Our analysis suggests the majority of BDCs under coverage have ample liquidity and capacity for new investments.
Four top BDC companies are the favorite picks at Truist, and all their stocks are rated Buy. It is important to remember that no single analyst report should be used as a sole basis for any buying or selling decision.
Ares Capital
Ares Capital Corp. (NASDAQ: ARCC) is a leading specialty finance company that provides one-stop debt and equity financing solutions to U.S. middle market companies, venture capital backed businesses and power generation projects. Ares Capital originates and invests in senior secured loans, mezzanine debt and, to a lesser extent, equity investments through its national direct origination platform. The company’s investment objective is to generate both current income and capital appreciation through debt and equity investments primarily in private companies.
Top Wall Street analysts believe the strength of the company’s origination platform, sizable balance sheet and ample liquidity position it favorably in a very competitive investing environment. Some believe that with the current tight spread environment Ares Capital has the scale and industry relationships to continue to make competitive, high-credit-quality investments. The Truist team agreed and said this:
Despite the intense competitive environment and continued economic uncertainty due to the COVID-19 fallout, we believe the tailwinds from incremental leverage (aided by the company’s scale and reach) should benefit net investment income growth and provide a comfortable cushion between earnings and dividends beginning in 2021. The company’s healthy realized gains keep its overall taxable income well in excess of its $0.40 regular dividend with a spillover of $410 million or $0.96 per share (as of September 30, 2020).
Investors receive an 8.84% dividend. The Truist price target for the stock is $18, which compares with a $17.43 Wall Street consensus target. The stock was last seen trading on Friday at $18.109.
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