Heading into 2025, market watchers are beginning to plan strategies based on a return to pro-business and deregulation policies. The prospect of lower inflation and lower interest rates promises relief from debt pressures, which will be beneficial for lenders and other financial services providers.
This will focus investors’ attention on BDCs, business development companies. These are investment firms that operate outside the traditional banking system, but make capital and credit available to small and medium-sized companies. It is a vital niche, supporting a major driver of the American economy.
A key feature of BDCs that makes them attractive to their investors is their tendency to pay high dividends. These companies are offering capital, which means they have to bring in capital – and their investors expect returns. Dividends provide a convenient way for BDCs to return capital to their own investors. It’s a feature that makes these companies a solid addition to any set of dividend stocks in the portfolio.
Wells Fargo analyst Finian O’Shea is keeping a close eye on this sector. In a recent report, O’Shea highlighted the potential of BDCs, stating: “BDCs today appear to offer an improved relative entry point into the world of financial balance sheets. For example, a longer higher and longer with a strong economy development scenario could re-emerge for an attractive setup. This assumes that the credit losses are benign, which has been generally true, but with a growing dispersion.”
Delving deeper into the details, the Wells Fargo analyst makes it clear that he particularly likes two BDC dividend stocks, including one that yields a whopping 15%, which is a powerful return by any measure. We used the TipRanks platform to look up the details of these two BDCs. Let’s take a closer look.
Runway Growth Finance Corporation (RWAY)
The first stock on our list is Runway Growth Finance Corporation, a BDC that focuses on venture capital with minimal dilution. Runway’s business is primarily focused on venture debt, which provides capital support to new companies in the technology, healthcare and consumer niches. The company’s strategy, by avoiding dilution of the shares of its client companies, allows the founders and early investors of those companies to retain their ownership, a key point for many startups.
Runway Growth has been backing startups since 2015 and has backed more than 60 companies in that time, with 91 deals totaling approximately $3 billion in loan commitments. The target companies usually fit a profile; they are backed by venture capital or private equity, typically have annual revenues of $10 million to $20 million with high annualized growth, and are seeking loans in the range of $10 million to $75 million. Runway describes its mission as supporting passionate entrepreneurs in building innovative companies.
On the dividend front, Runway last announced the payment of common stock at 40 cents per share on Nov. 5. The dividend was paid on December 2. The annualized rate of $1.60 per share yields a forward return of more than 15.3%.
The company’s dividend has been supported by its recent financial results. In Q3 24, Runway posted total investment income of $36.7 million, although that figure exceeded expectations by $1.32 million. Ultimately, Runway’s net investment income was $15.9 million, which equated to 41 cents per share. Although this fell short of the forecast by 4 cents per share, it was sufficient to fully cover the regular dividend payment.
Covering this company for Wells Fargo, analyst O’Shea notes that this BDC is near the bottom of a cycle – and that the current state of the company presents a good opportunity to buy. He writes: “RWAY shares have lagged the sector. by ~18% on a YTD total return basis and trading at 0.78x book value, and could revalue following a shift from what is likely ‘peak pessimism and uncertainty’ to what we see as a more accurate consensus NOI estimate… We are upgrading RWAY (from EW to OW) as we think sentiment has likely bottomed and its valuation carries more potential upside than downside risks.”
Along with his upgraded Overweight (Buy) rating, O’Shea puts an $11 price target on the stock, implying a 5% upside in the coming months. Add the dividend yield and the total annual return on these shares can exceed 20%. (To view O’Shea’s track record, click here)
There are only 3 recent analyst ratings available for RWAY stock, and they include 2 Buys to 1 Hold for a Moderate Buy consensus rating. The shares have a current trading price of $10.44 and their average price target of $11.08 points to a one-year gain of 6%. (To see RWAY stock forecast)
Ares Capital Corporation (ARCC)
The next stock on our BDC list is Ares Capital Corporation, a major lender in the US small business sector. This is an important niche in the financial services industry, as small and medium-sized businesses are the traditional engine of the U.S. economy. Ares Capital Corporation has 20 years of experience in this field and provides an essential service to its clients: it provides the resources they need to survive.
Ares Capital Corporation has built a substantial portfolio in its twenty years of operation, with a fair value estimated at $25.9 billion. This portfolio consists of 535 companies, which are in turn supported by 240 private equity sponsors. Looking deeper into the analysis, we see that almost 53% of the portfolio consists of senior secured first lien loans. Senior secured second lien loans and preferred stock each represent approximately 10.5% of the total. By industry composition, Ares Capital’s portfolio consists of just over a quarter of software and services companies; Healthcare sector companies account for 12.8%, and commercial and professional services companies account for 10.7% of the total.
The returns on this portfolio form Ares’ income stream, which in the last reported quarter, 3Q24, totaled quarterly investment income of $775 million. This figure was up more than 18% year-over-year and was nearly $1.7 million better than expected. Operating income, non-GAAP earnings per share of 59 cents, was 1 cent lower than forecast.
Despite the lack of earnings per share, the company’s income still easily covers the dividend. Ares Capital Corp. announced a common share payment of 48 cents on October 30, with a payout on December 30. The annualized rate of $1.92 per common share yields a substantial future return of ~8.7%.
Looking at this stock, O’Shea is impressed by Ares Capital’s strong performance and the high quality of its portfolio. He says of the company: “In a market where many more average performing companies are at or near book value, ARCC gets the award for reliability, which has again been demonstrated through the best credit performance throughout the Fed’s campaign. Credit performance YTD 2024 and since 2022 are both number 1 in our coverage, with gains from equity investments including Heelstone helping to cover credit losses…”
Describing the opportunities here, the analyst adds: “Thematically, we see a lower base rate as likely positive for ARCC, which has an impressive record in junior/structured credit. Lower rates could lead to an expansion of these options for ARCC.”
This is another stock getting an upgrade from the Wells Fargo analyst; its Overweight (Buy) rating here is up from Equal Weight. O’Shea’s $23 price target suggests the stock will have a gain of 4% this time next year. With the dividend yield, the total return on ARCC could rise to almost 13% in the coming year.
The Street generally likes this stock, as evidenced by the Strong Buy consensus rating – a rating backed by 10 reviews with a breakdown of 8 Buys to 2 Holds. The shares are priced at $22.10, and the average target price of $22.40 implies they will remain within the range for now. (To see ARCC stock forecast)
To find good ideas for stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a tool that unites all of TipRanks’ equity insights.
Disclaimer: The opinions expressed in this article are solely those of the featured analyst. The content is for informational purposes only. It is very important to do your own analysis before making an investment.
