“Dividend Superstars: Part 2 … Shipping and Secret Investments”

By Travis Johnson, Stock Gumshoe, August 2, 2008

This is the continuation I promised on the “Dividend Superstars” teaser from Weiss Research — we looked first at the rural telecom company with the 10%+ yield, and now we’re moving on to a secret investment company and a shipping company, both with yields over 15%.

If you’d like to hear my introductory blathering and read about the telecom pick, you can either go back in time or click here to catch up. For the rest of you, let’s move on …

“Dividend Superstar#2: 15.7% Yield from a Secretive Investment Company That’s Paid Dividends for 43 Quarters Straight”

What kind of clues do we get for that?

“… you can buy this company’s shares and it pays very juicy, steady dividends. It currently has about 220 businesses in its portfolio. That gives it tremendous diversification across sectors and industries.

“What’s more, because of the way this company is structured … It must keep its debt under control, making it one of the least leveraged publicly traded financial companies in the U.S., and …

“It must pay out 90% of its profits to shareholders in the form of dividends!

They have paid a dividend for 43 quarters in a row, for all of their 11 years as a public company, for a total payout over that time of more than $2.3 billion. Doesn’t help us much, I suppose, but that’s a fair chunk of change.

And their dividend has compounded at a growth rate of 12%. Not bad.

The company, dividends included, has returned about 18% a year for the last decade.

So that all sounds lovely, no? What is our fine divvie king?

Thinkolator sez …

This is American Capital Strategies (ACAS)

ACAS is one of several BDCs and similar mid-market lenders who are based within a stone’s throw of my home in Washington, DC — Allied Capital and CapitalSource are two other nearby ones. A BDC, for those who don’t know, is a Business Development Company, and they have quite similar rules to REITs — they are not taxed on the corporate level, but have to restrict their leverage (1:1, I believe, meaning they can borrow only 100% of their portfolio value, versus investment banks that typically have levered up 30:1), and pay out most of their earnings as taxable dividends to shareholders.

What do these guys do? Essentially, ACAS and most of their competitors, compalies like Allied Capital, Gladstone Capital, and Apollo Investments, raise money by selling equity, and use that money to lend to midsize companies that are too large to go to the neighborhood bank, and too small or disinterested to be publicly traded. This can take several forms, sometimes they are straight loans, sometimes they are equity investments combined with loans … these are essentially private equity companies that don’t use much leverage.

So … because they’re lending to these relatively small companies and taking equity positions in many cases, they can get higher returns than a bank might, even with lower leverage, so they have tended to have very nice dividends, 6-7% when they were popular investments in past years, and often 20% now that everyone is terrified of companies that do any kind of lending.

I can’t tell you all about ACAS here — it was started by a very colorful guy in his apartment in Bethesda, MD not much more than ten years ago, and has been an incredible grower during that time — they really have paid out more than $2.3 billion in dividends since they went public in 1997, not bad for a company with a current market cap of about $4 billion.

And they are hated, hated, hated right now. The teaser indicated this was a 15% yield, and it was not long ago, but the shares have taken quite a beating, down 20% in just about two weeks. They release earnings next week, on August 6 — an august day, indeed, being also the anniversary of the birth of the mighty Gumshoe.

I’ve been intrigued by this company from afar for a long time, but haven’t been willing to take a chance on them just yet — it’s getting to the point where the shares are so inexpensive that I might get interested soon, they do have a very diversified portfolio of equity and debt holdings, and they just spun off an IPO of a company that will invest in agency (mostly mortgage) debt, so they’re not standing still during this turbulent period. There was a big volume selloff of the shares a few weeks ago, but other than that the shares have not traded anywhere near this low since 2003.

There are absolutely some risks with this one — they took a hit when they had to adopt new accounting rules in the first quarter of this year, essentially the same mark-to-market rules that made all the banks look bad (they have to write down a loan to fair current value and report that change on the income statement whether or not they sell the loan). At the price it’s trading now, a significant discount to last quarter’s book value, I have to assume that investors are afraid of more writedowns or future dividend cuts — management has said that they expect $4 in dividends this year, which would mean maintaining the current rate, though who knows if that promise extends to 2009. The cash earnings that they have to pay out as dividends (at a 90-98% rate, generally) are not the same as the accounting earnings, since with the mark to market writedown last quarter they actually reported a loss, but still paid a hefty dividend of over $1.

The big question for ACAS investors, or investors in any of these BDCs, is whether you think they’ll take a beating on loan defaults from their portfolio companies — will the nonperforming loans spike up if and when the economy continues to struggle? It’s certainly always possible, and that rate has gone pretty high during tough economic times before — I like that ACAS has a relatively large and diversified portfolio, and has a history of openness about their portfolio positions, but that’s no guarantee that they won’t suffer, even suffer more than they already have.

I’ll be watching this one around