One of the best aspects of putting your money to work on Wall Street is that you don’t have to conform to any blueprint. With thousands of publicly traded companies and exchange-traded funds (ETFs) to choose from, there’s a very high probability of finding one or more securities that matches your investment goals and risk tolerance.
But among the countless ways investors can build their wealth on Wall Street, few have proven more successful over long periods than buying and holding high-quality dividend stocks.
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Companies that regularly dole out a dividend to investors are almost always profitable on a recurring basis, time-tested, and capable of providing transparent long-term growth outlooks. In other words, they’re typically established businesses that have demonstrated to investors they can navigate challenging periods and thrive during long-winded economic expansions. These are just the type of companies we’d expect to increase in value over the long run.
But you don’t have to take my word for it. Recently, the investment advisors at Hartford Funds updated their data from a report released last year (The Power of Dividends: Past, Present, and Future), which examined the degree of outperformance between dividend stocks and non-payers over the long-term.
According to Hartford Funds, in collaboration with Ned Davis Research, non-payers produced a modest average annual return of 4.27% between 1973 and 2023, and did so while being 18% more volatile than the benchmark S&P 500. On the other hand, dividend stocks more than doubled up the average annual total return of non-payers over the previous half-century (9.17%), and were also 6% less-volatile than the S&P 500.
While dividend stocks have a phenomenal track record of making patient investors notably richer, studies have also shown that risk and yield tend to go hand in hand.
For example, a company with a struggling operating model and a declining share price has the potential to lure income seekers into a yield trap. Since yield is a function of payout relative to share price, companies with ultra-high-yields (i.e., yields that are four or more times greater than the S&P 500’s yield) require extra vetting by investors.
But this doesn’t mean all ultra-high-yield dividend stocks are necessarily trouble. With the proper evaluation, ultra-high-yielding gems can be found. In fact, some of the safest supercharged dividend stocks might just be companies you’ve never heard about.
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Although mortgage real estate investment trusts (REITs) are the typical go-to for investors looking for supercharged yields, I’d argue there’s an even better way to secure a gargantuan annual yield and more than double your money every decade. Meet little-known business development company (BDC) PennantPark Floating Rate Capital(NYSE: PFLT), which is currently yielding 11% and doling out $0.1025 per share on a monthly basis!
A BDC is a company that invests in the equity (common and preferred stock) and/or debt of middle-market businesses. “Middle-market” companies are typically unproven micro- and small-cap businesses that may or may not be publicly traded.
When PennantPark lifted the hood on its fiscal third-quarter operating results for the period ended June 30, it was overseeing a nearly $1.66 billion investment portfolio. Although it held an assortment of preferred- and common-stock equity totaling $208.6 million, the roughly $1.45 billion in debt securities it owns makes it a predominantly debt-focused BDC.
Since most middle-market companies are unproven and lack access to basic financial services, PennantPark is able to generate a market-topping yield on its loans. During the June-ended quarter, its weighted average yield on debt securities was a scorching-hot 12.1%, which is almost triple the yield you’ll receive from a 10-year Treasury bond.
However, the biggest advantage PennantPark Floating Rate Capital brings to the table can be seen in its name. The entirety of its debt-securities portfolio is based on variable rates. With the Fed increasing interest rates at the fastest clip in four decades between March 2022 and July 2023, PennantPark’s weighted average yield on debt investments surged by a peak of 520 basis points from where things stood on Sept. 30, 2021.
Although the nation’s central bank has kicked off a rate-easing cycle, returning to a historically low federal funds rate of 0% to 0.25% doesn’t look to be in the cards. With the Fed slow-stepping its monetary policy shift, there’s plenty of runway for PennantPark to generate superior yields from its debt investments.
The steps PennantPark’s management team has taken to protect its principal also explains its success. For instance, the company’s roughly $1.66 billion portfolio, including equities, is spread across 151 companies, which works out to an average investment size of $11 million. No wager is too big to upend PennantPark.
What’s more, 99.9% of the company’s debt investments (all but $1.2 million) are of the first-lien secured variety. First-lien secured debtholders find themselves at the front of the line for repayment in the event that a borrower seeks bankruptcy protection. Despite working with generally unproven businesses, only 1.5% of PennantPark’s debt investments were on non-accrual (i.e., delinquent), as of June 30.
Since going public in 2011, PennantPark Floating Rate Capital has delivered a 187% return to its shareholders, including dividends. Though this doesn’t hold a candle to Wall Street’s prominent tech stocks, it’s a phenomenal return for a monthly dividend payer that can sustain its 11% annual yield.
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Sean Williams has positions in PennantPark Floating Rate Capital. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
