Even after spending two decades on Wall Street, I occasionally run across stocks that I’ve never heard of.
It doesn’t happen often, but imagine my surprise when I discovered that this week’s find has a fat dividend yield.
Capital Southwest Corp. (Nasdaq: CSWC) is a business development company (BDC).
BDCs invest in private companies. They also usually pay big dividends.
Capital Southwest is no exception. This year, it will pay out $1.72 per share in dividends to its shareholders. That gives Capital Southwest a yield north of 7%.
But that 7% yield doesn’t tell Capital Southwest’s entire dividend story. It also has a history of paying out what the company calls “supplemental dividends.” Last year, it paid out supplemental dividends of $0.10 per share each quarter.
The supplemental dividends were approved by the board of directors in 2018 and are expected to continue this year. That brings the total supplemental and ordinary dividends Capital Southwest is expected to pay out this year to $2.12 and its forward yield to nearly 8.9% – not too shabby for a BDC I’ve never heard of.
While a regular dividend is often paid out quarterly or monthly, a special dividend is a one-time dividend issued in addition to the regular one. It’s not expected, and there’s no guarantee that a special dividend will reoccur.
Meanwhile, Capital Southwest’s supplemental dividend is a regularly occurring dividend paid in addition to the ordinary dividend.
Can it continue generating substantial income for investors? Let’s dig into the company’s financials to find out.
In Capital Southwest’s last fiscal year, which ended on March 31, the company’s net investment income (NII) was $31.67 million.
NII is the income a BDC earns from its investments in assets like loans, bonds, stocks, etc.
NII is the best measure of the cash that a BDC generates. It’s also the best way to determine a BDC’s ability to pay a dividend since it represents a BDC’s cash flow.
Capital Southwest’s NII is heading in the right direction. NII grew 12.2% from the $28.23 million it produced in its fiscal year 2020. And over the last three years, NII has almost doubled. It’s up 95.13% from $16.23 million in fiscal 2018.
There aren’t any NII estimates, so Oxford Income Letter subscribers won’t find Capital Southwest listed in the automated SafetyNet Pro database. However, net income is expected to rise, so we’ll assume that NII will be higher this year as well.
So far, so good. Let’s take a look at how much cash the regular and supplemental dividends are costing the company.
Last year, Capital Southwest paid out nearly $40 million in dividends. Despite trending in the right direction, NII fell $8.23 million short in 2020.
This year, the BDC’s dividend bill will likely remain the same. Even though the company’s NII this year should be higher than last year’s, it’s unlikely that it will cover the dividend.
Sometimes BDCs sell stock so that they have cash to make additional investments. Those investments will, in turn, increase NII.
If the BDC isn’t able to generate enough NII in the near future, the supplemental dividend that investors have counted on for three years could be at risk.
Dividend Safety Rating: C
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Good investing,
Kristin