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Prospect Capital: A Recipe For Profit (If You Can Stand The Boredom)

June 29, 2014 | About:

One of the great ironies of being an individual investor who performs their own due diligence is that we avoid paying others to manage our money for us but then invest in stocks where we are paying the people running the business to manage our money for us. It is a bit funny when you think about it in that light. Today, I have found a business that takes that irony even one step further by taking investors’ money and using it to help finance the business pursuits of their customers. So, in essence, investors in Prospect Capital Corporation (PSEC) are paying them to find people to whom they can loan money in return for being paid for the funds and business expertise they bring to the table. While this might sound complicated, it is not.

Peter Lynch once said you should never make an investment that you can’t illustrate on a piece of paper with a crayon. Prospect Capital operates as what is called a business development company under the Investment Company Act of 1940. This law allows for a business that loans money to small and mid-sized businesses to avoid paying income taxes as long as they distribute almost all of their income directly to shareholders. It is like a publicly traded, private equity firm. It is also so transparent that I was startled by how easy their website made this analysis.

As a value oriented, contrarian investor, I am accustomed to digging deeply into the financial reports and SEC filings of a business to look for ways to project the potential returns from an investment under consideration. It is so rare to find a situation where this information is handed to me on the company’s website that I found myself overwhelmed by suspicion when it occurred today. There are times when I find it difficult to understand exactly what a particular business does and how it is going to make money. That is not the case with Prospect Capital. I simply went to the page on their website that describes their business and here is what I found:

Long-term Relationships

Transaction Situations

Investment Structures

• Private Equity Sponsors

• Management Teams

• Founders

• Financial Intermediaries

• CLO Collateral Managers

• Other Lenders

• Refinancings

• Leveraged Buyouts

• Acquisitions

• Recapitalizations

• Later-stage Growth Investments

• Capital Expenditures

• First and Second-Lien Debt

• Unitranche and Mezzanine Debt

• “One-Stop” Debt-and-Equity Financings (of entire capital structures)

• Equity Co-Investments

• CLO Equity and Subordinated Debt

This is a very concise presentation of what many business management groups would have made complicated and confusing. Prospect Capital is in the business of investing in and loaning capital to small and mid-sized businesses under very attractive terms.

What Should Investors Expect Going Forward

Much of the effort I put into analyzing a business is spent in an attempt to predict how the company is going to reward the allocation of my capital going forward. As with figuring out what this business does to make money, finding out how I will be rewarded going forward was just a matter of clicking on the dividend page of the website and they tell me what I can expect to be paid going forward.

Ex-Dividend Date

Record Date

Announce Date

Pay Date

Amount

Frequency

12/29/2014

12/31/2014

05/06/2014

1/22/2015

0.110600

Monthly

11/26/2014

11/28/2014

05/06/2014

12/18/2014

0.110575

Monthly

10/29/2014

10/31/2014

05/06/2014

11/20/2014

0.110550

Monthly

9/26/2014

9/30/2014

02/03/2014

10/22/2014

0.110525

Monthly

8/27/2014

8/29/2014

02/03/2014

9/18/2014

0.110500

Monthly

7/29/2014

7/31/2014

02/03/2014

8/21/2014

0.110475

Monthly

6/26/2014

6/30/2014

11/4/2013

7/24/2014

0.110450

Monthly

Now, many people would think that it just doesn’t get any better than this; but they would be wrong. At the top of the table I posted above, the company has calculated the annual dividend yield for me and prominently posted the 12.62% figure where it is easy to find. Of course, it is easy to understand why they would want to post THAT figure quite prominently!

As they say in the TV infomercials: But wait! There’s more! Not only has the company already announced what it will pay investors through the end of this year; they have stated that they expect to announce the dividends for the first quarter of 2015 in August of this year. Talk about removing the guess work from investing.

While it a common disclaimer that past results should not be construed as indications of future performance, it is worth noting that Prospect Capital will have made 77 consecutive distributions to shareholders since 2004 by the time they complete the payments of the dividends that have already been announced. This might not be a promise for the future but it certainly shows their hearts are in the right place and the checks have always followed. The website even has a total return calculator so investors can actually see how their investment would have performed in retrospect. I played with it a bit and found that a $10,000 investment made on January 1, 2005 would have been worth slightly more than $24,500 at the end of 2013. And that is without the investor lifting a finger!

Not only do the people in charge of Prospect Capital know how to make it easy to analyze their business, they also seem to know how to make it easy for their shareholders to make a profit.

Final Thoughts And Actionable Ideas

First of all, I have to say that along with Realty Income Corporation (O), also known as “The Monthly Dividend Company”, Prospect Capital is one of the easiest businesses to analyze that I have ever come across. In the case of Prospect, I could have virtually copied and pasted their website into my article and provided everything needed to make an informed investment decision. Prospect Capital probably has the most investor friendly website I have ever seen. I actually enjoyed the website experience so much that I spend at least three hours just looking around on it and checking out all of the helpful information and tools they provided.

This is a business that seems to meet many, if not all, of Peter Lynch’s criteria for the allocation of capital. Even though the details of some of their deals can be quite complex, the business model itself is very easy to understand. They are clearly interested in richly rewarding their shareholders and have told everyone well in advance exactly what can be expected.

Best of all, at the current price, this company provides long-term buy and hold investors with a 12.62% yield. It is hard for me to imagine that buying this stock today will not only reward me with a very rich dividend yield beginning immediately, but also with substantial capital gains in the years to come as other yield starved investors figure out what they have been missing. I believe a 15% annualized return on my capital between dividends and share price appreciation is a very conservative expectation for this particular opportunity. That my friends is world-class performance with VERY little effort.

If you have never seen what a real shareholder friendly website looks like, don’t pass up the opportunity to visits Prospect Capital’s and find out for yourself.

About the author:

Ken McGaha
Ken McGaha has been managing his own investment portfolios for over 20 years. On July 20, 2012 he launched the Self-Made Millionaire Tracking Portfolio with a portion of his capital as an aid to teach younger members of his extended family how he built his own investment portfolios and maintains them today.

Ken's Self-Made Millionaire website now has subscribers in at least 13 countries and the Self-Made Millionaire Tracking Portfolio has delivered a 28.36% annualized rate of return on capital between July 20, 2012 and June 21, 2014.

In late December of 2013, Ken added the Maggie's Money Mountain Tracking Portfolio to his website to show young investors with limited capital how he would invest and trade an account with $4,500 in order to grow it at a compounded rate of 12% annually. From December 30, 2013 through June 21, 2014, this account has produced an actual return of 26.05%.

Visit Ken McGaha's Website


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