You May Not Be Glad About This 7.5% Yield

I’m a fan of business development companies (BDCs) that invest in private businesses and typically pay big dividends to shareholders.

Gladstone Investment Corp. (Nasdaq: GAIN) is a BDC that offers a 7.5% yield and pays shareholders monthly.

Gladstone recently increased its dividend to $0.065 per share. It will also pay a special $0.06 per share dividend in December.

Gladstone Investment’s portfolio is 75% debt securities (loans) and 25% equity.

Its investments include…

A $9.6 million secured second lien loan at 14% to Precision Southeast, a South Carolina manufacturer of injection molded components. It also owns 37,000 preferred shares and 91,000 common shares of the company.

A $13.3 million loan at 13.5% and an equity position in Ginsey Home Solutions, which makes bath toys, toilet seats, shower speakers and other items for the home.

A $5 million, 12.5% loan along with 1,500 shares of preferred stock and 600 shares of common stock of Star Seed, an Osborne, Kansas-based seed products company.

In Gladstone’s last fiscal year, which ended March 31, the company’s net investment income (NII) was $0.74 per share. NII is the best way to measure a BDC’s business and its ability to pay its dividend.

During the year, it paid $0.75 per share in dividends. That means it paid out more in dividends than it brought in from NII. The year before, NII was $0.68, while it paid out $0.75 in dividends. So it has a recent history of paying more out in dividends than it earns. That’s not good.

In the June quarter, the same pattern repeated. NII was $0.17 per share, but the company paid out $0.19 in dividends.

Though the company raised the dividend just a few weeks ago, it cut the dividend in 2009. There have been other times when the total dividends for the full year were lower than they were the year before, but that was due to special dividends and are not considered a cut if the company doesn’t pay it again the following year. In 2009, however, the regular monthly dividend was cut in half.