• Business development companies (or BDCs) offer generous yields to income investors.
• Great Elm Capital (GECC) is a BDC that makes loans and middle market investments.
• Newtek Business Service (NEWT) provides financial and business services to small and medium-sized businesses in the U.S.
• Capital Southwest (CSWC) offers credit and private equity investments in middle market companies, but also invests in buyouts, recapitalizations and late venture-stage companies.

When it comes to investing for dividends, the strategies that are available in the market are numerous. They include investing for dividend growth, dividend safety, and the subject of this article, high current yield. Depending upon one’s goals, one of these may suit best, or in some cases, a combination of these strategies is best.

As part of executing a strategy that involves seeking high yields, sector selection plays a big role. After all, technology and consumer discretionary stocks, for instance, tend to have low yields, so they’d be inappropriate. So where can investors turn for high current yields?

Business development companies offer generous yields because they’re required to distribute substantially all of their earnings to shareholders. BDCs receive favorable tax treatment, and in return, they aren’t allowed to retain earnings in the same way other companies are. That’s good for income investors because yields in the sector are routinely in the mid-single digits or better.

In this article, we’ll take a look at three BDCs we like today with high dividend yields, even by BDC standards, to help jumpstart the search for high-yield components for an investor’s portfolio.

BDCs: Great Elm Capital (GECC)

Our first BDC is Great Elm Capital, a BDC that makes loans and middle market investments. The company primarily makes debt investments from which it hopes to generate interest income, although it does make targeted income-producing equity investments at times.

Great Elm has a relatively narrow focus for a BDC, in that it prefers investments in media, commercial services and supplies, healthcare, telecom, and communications equipment. Many BDCs choose to diversify their industry exposure as much as possible to reduce risk, but Great Elm has chosen a more targeted strategy.

The company typically invests between $3 million and $10 million per target company, and targets generally have between $3 million and $75 million in annual revenue. These are companies that are generally to small to be able to access public markets funding, which is where the BDC steps in, the so-called “middle market.”

Great Elm was founded in 2016, so it’s a relatively new firm, is set to produce about $27 million in revenue this year, and trades with a market capitalization of $67 million. Given this, scale is certainly not an advantage Great Elm enjoys.

Great Elm made the list because it’s yield is otherworldly, clocking in at a staggering 16.6%. This is due to an extremely high payout, but also the bout of weakness the stock has suffered so far this year. This combination has produced a world-beating yield, but of course, this kind of yield carries with it inherent risks.

Investors would generally flock to a “guaranteed” 16% annual return through dividends, but in Great Elm’s case, the market is likely discounting a dividend cut. The company’s most recent dividend paid was 60 cents per share, paid on a quarterly basis, or $2.40 per share annually. However, we see earnings at just $1.53 for this year, meaning there’s a funding gap of nearly a dollar per share. Great Elm can fill that gap temporarily through debt or equity issuance, but those methods cannot carry on forever.

Thus, we caution on Great Elm that the yield is extremely high today, and may remain that way for some time, but that the risk of a dividend cut is quite elevated.

Newtek Business Service (NEWT)

Our next BDC is Newtek Business Service Corp. a company that provides financial and business services to small and medium-sized businesses in the U.S. Newtek operates a segment that is a traditional BDC – one that makes investments in middle market companies – but it also has a diverse suite of other services it provides outside the normal realm of a BDC.

Other services include electronic payment processing, loan origination, technology solutions such as web hosting and data storage, insurance, payroll management, tax filing and much more.

Newtek was founded in 2013, should generate about $79 million in revenue this year, and trades with a market capitalization of $612 million.

Newtek pays a variable dividend, so it rises and falls with each declaration, typically. The most recent quarterly dividend was 75 cents per share, or $3 on an annualized basis. That is good enough to give Newtek a 13% yield today, but as was the case with Great Elm, investors must understand the risk involved.

We see $2.66 in earnings for this year on a per-share basis, meaning the most recent dividend – on an annualized basis – would exceed earnings. Whether that results in a cut ultimately remains to be seen, but for now, Newtek offers a yield that is about 10 times that of the S&P 500.

BDCs: Capital Southwest (CSWC)

Our final BDC is Capital Southwest, a BDC that offers credit and private equity investments in middle market companies, but also invests in buyouts, recapitalizations, and late venture stage companies. The company is highly diversified in terms of industry exposure, and investments tend to range between $5 million and $25 million per portfolio company. Capital Southwest selects companies with $10 million in revenue or more, profitable operations, and a growth rate of at least 15% annually.

The BDC was founded in 1961, should produce about $83 million in revenue this year, and trades with a market capitalization of $558 million.

Capital Southwest’s most recent dividend declaration included a payout of 48 cents per share for the regular dividend, but also a special dividend of 15 cents per share. The normal payout annualizes to $1.92, or a yield of 8.2%. The special dividend boosts that by another 0.6%.

While the yield is lower for Capital Southwest than the others on this list, we see its payout as much safer. We believe Capital Southwest can produce almost $2 per share in earnings this year, meaning it can very likely cover the dividend.

Final Thoughts

While not all BDCs are created equal, if one knows where to look, some truly outstanding dividend yields can be found. We’ve highlighted three examples – Great Elm, Newtek, and Capital Southwest – that offer market-beating yields with varying levels of safety and growth.

While BDC investing isn’t suitable for everyone, for those focused on income generation, the group can provide a pure-play income opportunity.