Updated on March 4th, 2023 by Samuel Smith
As the saying goes, if something looks too good to be true, it usually is just that. This can often be applied to unusually high-yielding dividend stocks, many of which have to cut their dividends in a recession.
For example, Stellus Capital Investment Corp. (SCM) has an over 10.5% dividend yield, which is very attractive on the surface. The S&P 500 Index, on average, has a dividend yield of just 1.6%.
Not only that, but Stellus pays its dividend each month, rather than each quarter like most companies. This helps to make Stellus stand out, as we currently cover just 69 monthly dividend stocks.
You can download the full list of monthly dividend stocks (along with important financial metrics such as dividend yields and payout ratios) by clicking on the link below:
However, while high dividend stocks are very appealing in a relatively low-rate environment, investors must make sure the dividend is sustainable.
Stellus has a very high payout ratio near 100%. As a BDC, Stellus is required to distribute essentially all of its income, so its payout ratio will always be high. However, it is in investors’ best interests to carefully monitor the company’s earnings performance for signs that a cut in the distribution may be coming.
This article will discuss Stellus’ fundamentals as they pertain to supporting its over 10.5% dividend yield.
Business Overview
Stellus is a Business Development Company, or BDC. It makes investments in small, predominantly private companies that are usually at an early stage in their growth cycles.
Stellus is a middle-market investment firm and makes equity and debt investments in private middle-market companies. The company provides capital solutions to companies with $5 million to $50 million of EBITDA and does so with a variety of instruments, the majority of which are debt.
Stellus provides first lien, second lien, mezzanine, convertible debt, and equity investments to a diverse group of customers, generally at high yields, in the US and Canada.
Source: Investor Presentation
It also has a highly diversified investment portfolio, both geographically and in terms of industry concentration. Stellus will make a variety of debt investments, including first lien, second lien, uni-tranche, and mezzanine financing.
The investments are placed in a variety of industries, including business services, industrial, healthcare, technology, energy, consumer products, and finance. Invested capital is used for a wide range of purposes, including acquisitions, growth investments, and more. Stellus is externally-managed, by Stellus Capital Management LLC, a registered investment advisor.
The company follows a disciplined investment strategy. In prior years, it closed only about 2% of deals reviewed. Its relative selectiveness allows the company to focus on the highest-quality investments.
It also means the company has far more investment opportunities than it needs, enhancing its ability to select only the best investments. Stellus generates particularly high yields from its first lien, second lien, and unsecured debt investments.
Next, we’ll take a look at the company’s growth prospects.
Growth Prospects
A strong catalyst for Stellus is its growing investment portfolio. Stellus has seen its investment portfolio rise at a rapid pace over the past five years, which has allowed the company to earn higher investment income.
However, this all stopped in 2020 as the coronavirus pandemic sent the U.S. economy into a deep recession, negatively impacting many of Stellus’ investments.
The good news is that the company’s results seem to have stabilized. Stellus reported fourth-quarter and full-year earnings on March 1st, 2023. For the years ended December 31, 2022 and 2021, the company reported net investment income of $28.6 million ($1.46 per common share based on weighted average common shares outstanding of 19,552,931) and $19.8 million ($1.01 per common share based on weighted average common shares outstanding of 19,489,750), respectively.
The company also reported core net investment income, which is a non-U.S. GAAP measure that excludes the capital gains incentive fee and income tax expense accruals. For the year ended December 31, 2022, core net investment income was $26.9 million or $1.38 per share. For the year ended December 31, 2021, it was $23.7 million or $1.22 per share.
Dividend Analysis
As far as dividend stocks go, Stellus is not a typical choice. It has a relatively short dividend history of fewer than 10 years, which means it has not yet developed a long track record of consistency.
You can see an image of the company’s distribution history below:
Source: Investor Presentation
Stellus currently pays a monthly dividend of $0.1333 per share, equating to an annualized payout of $1.5996. The company cut its dividend in mid-2020 due to the pandemic. On a positive note, Stellus regularly pays out special distributions to further supplement its attractive monthly dividend.
Net investment income is expected to come in at $1.78 per share for 2023. With the current annualized dividend of $1.5996, Stellus is currently carrying a payout ratio of 90%. This means the current dividend payout is sustainable, but just barely. Keep in mind BDCs are required to distribute nearly all of their income, so Stellus’ payout ratio will always be high.
Even so, the company does not have much wiggle room. Even a modest decline in investment income could cause the payout ratio to rise above 100%, which signals a potentially unsustainable dividend.
Stellus must continue to increase its investments, as its recent results indicate. Stellus is a high-risk, high-reward dividend stock. If the company’s growth stays on track, investors will receive a ~10.5% return just from the dividend, plus any capital appreciation from a rising share price.
Even if the company does maintain its dividend, investors should not expect much in terms of dividend growth going forward. Net investment growth has been sluggish and given the high payout ratio, we don’t see any catalysts for a higher payout in the near future.
Final Thoughts
Stellus could be an attractive pick as it has a 10.58% dividend yield and some measure of growth potential.
Plus, Stellus pays its dividend each month, which helps boost the compounding effect of reinvested dividends and enhances the attractiveness of the stock for those relying upon dividends for living expenses.
Of course, there is no guarantee the company’s growth plans will be successful and with a payout ratio nearing 100%, there is not much room for error. As a result, investors must accept the risk of a future dividend cut if financial results deteriorate. Only investors willing to take this risk should consider buying the stock.
If you are interested in finding more high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be useful:
The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them monthly:
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