To earn a 9% yield, investors have to be willing to take on some risk.
Yields approaching double digits are tough to find.
[ad#Google Adsense 336×280-IA]Investing in mortgage REITs and business development companies (BDCs) is about the only way to earn that kind of yield in today’s market.
A BDC is a publicly traded company that invests in privately held businesses. Most invest in debt or lend money to companies directly. Some take an equity stake.
The private businesses typically don’t qualify for bank loans, so they must pay higher interest rates to the BDCs willing to fund them. And because of the higher rates they earn, BDCs pay shareholders fairly high dividend yields.
However, a BDC’s yield isn’t always consistent.
If a company defaults on its loan, the dividend will likely fall. If the company sells one of its investments for a profit, the dividend may increase.
One of my favorite BDCs is New Mountain Finance Corp. (NYSE: NMFC). It’s currently in the Retirement Catch-Up/High Yield Portfolio of The Oxford Income Letter, my dividend investment newsletter.
The company has a very strong history of making smart loans. Its nonperforming loans are miniscule. From a safety perspective, this makes me comfortable that its dividend won’t have to be reduced because borrowers aren’t paying their loans on time.
Speaking of its dividend, New Mountain Finance pays $0.34 per share quarterly, which comes out to a 9% yield. Additionally, when there are extra funds available, the company pays a special dividend. Its last special dividend was paid in 2014.
To assess the dividend health of a regular company, SafetyNet Pro analyzes cash flow. BDCs use net investment income (NII) instead of cash flow.
Net investment income is just what it sounds like: how much money the company makes from its investments.
In 2016 and 2017, it’s estimated that the company’s NII will be $1.36 per share. That’s down from $1.39 in 2015 and $1.41 in 2014.
New Mountain Finance pays out $1.36 per share in dividends. So as long as NII comes in at $1.36 per share, the company will fully fund its dividend. If NII is lower, that means New Mountain will have to dip into cash on hand to pay its dividend.
If NII is higher than $1.36, it’d be a surplus that could be used for a special dividend or to buy back shares. The company currently has a $50 million share repurchase program authorized.
New Mountain Finance’s dividend track record is strong with no cuts to its quarterly dividend since it started paying one in 2011.
However, SafetyNet Pro penalizes New Mountain Finance for its declining NII.
If the company can maintain NII at $1.36 or higher in 2017, the stock will get an upgrade.
But until we see that happening, the dipping NII means that New Mountain Finance gets only a mediocre grade.
Dividend Safety Rating: C
Good investing,
Marc
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Source: Wealthy Retirement