The Prospects Just Got Dimmer for This 9.8% Yielder

Because of its high yield, Prospect Capital (Nasdaq: PSEC) is one of the most frequently requested stocks here in the Safety Net column.

My colleague Brittan Gibbons-O’Neill reviewed the stock’s dividend safety in April. Prospect Capital received a “D” rating because of its declining net investment income, its high payout ratio and its tendency to cut the dividend when the going gets tough.

Prospect Capital is a business development company. It invests in and loans money to other businesses that can’t get a bank loan. To determine whether Prospect Capital’s current dividend is sustainable, we need to look at net investment income – the money the company makes from its investments.

Prospect Capital’s fiscal year ends in June, so we would typically compare net investment income in the fiscal year ending in June 2022 with net investment income in the fiscal years ending in June 2021 and earlier years.

However, we can’t. Prospect Capital informed Wall Street last week that its 10-K filing will be late. The company said, “We expect to report a material weakness in our internal control over financial reporting.”

In other words, the company doesn’t know what its results are and spotted a serious problem with its accounting. That doesn’t guarantee disastrous financial results. But when there is a big error in a company’s financials, that error rarely makes the company look better. So when the mistake is resolved and the company revises its past results, the updated results are typically worse than the ones originally reported.

Based purely on Prospect Capital’s past results – which we don’t know whether we can rely on anymore – net investment income has risen in the past few years and would likely come in higher this year. But again, we have no idea what the numbers will actually be.

What we do know for sure is that the company cut its dividend twice – once in 2015 and once in 2017. The decline you’ll see in the chart below in 2018 came because the reduction in 2017 occurred in September, so the full-year dividend in 2018 was lower than the full-year dividend in 2017.

Prospect Capital pays a $0.06-per-share monthly dividend, which comes out to a 9.8% annual yield.

Management has shown a willingness to lower the dividend. And given that this year’s financials – and possibly those of the last several years – are now in question (my guess is that they’re headed lower), I think it’s very likely that Prospect Capital’s dividend will shrink once again.

Dividend Safety Rating: D

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Good investing,

Marc