I have always enjoyed unearthing and profiting from unusual investments. From unique niche stocks to rare antiques, locating under-the-radar investments is part of my DNA.
Recently, I was reminded of one such unusual investment -- Fifth Street Finance (Nasdaq: FSC) -- by my colleague, Joseph Hogue, who covered it for our sister site, StreetAuthority.com. The stock appears to be setting up for a profitable trade and has a double-digit dividend yield to boot.
This business development company (BDC) specializes in financing small and mid-sized companies. BDCs typically pays out most of their income in the form of dividends, and FSC currently pay $0.083 monthly for a 10.4% annual yield.
The current environment makes commercial financing difficult for many businesses. A recent survey by the Federal Reserve showed that while demand for business loans was increasing, just 10% of banks were willing to decrease their lending criteria for small businesses, and 3% of banks increased their standards.
The stringent criteria of traditional banks and lending institutions open the door for alternative financing provided by business development companies like Fifth Street Finance.
FSC and other BDCs have struggled this year, in part because investors are worried about the effect of rising interest rates. This is true for some, but FSC is an exception, which is the primary reason I like the stock right now.
Interest rates are slowly ticking higher, but 74% of FSC's investments are made with variable interest rates. It makes money on the spread between what capital costs and the rate at which it can lend it. The majority of its debt holdings are at LIBOR plus 5% to 10%. LIBOR is the rate banks lend each other money, and as it increases, the spread widens providing Fifth Street with more income.
In addition, FSC has a diverse portfolio of debt spread across 125 companies in a variety of industries. This helps offset the often higher credit risk of the individual companies in the portfolio.
In early May, FSC announced solid results for its fiscal second quarter. Net investment income of $34.2 million was down slightly on a sequential basis. Yet net asset value per share of $9.81 (as of March 31) is 3% above the current price, meaning investors have a chance to get into shares at a fundamental discount.
Taking a look at the technical picture, FSC is pushing up against double-top resistance at $9.60. Shares are trading above both the 50-day and 200-day simple moving averages. Additionally, we're seeing a potential bullish crossover of the 50-day through the 200-day, signaling further upside to come.
Action to Take -->
-- Buy FSC on a break above $9.60
-- Set stop-loss at $9.35
-- Set initial price target at $11 for a potential 15% gain in three months, plus dividends
This article originally appeared on ProfitableTrading.com:
Under $10 Stock With a 10%-Plus Yield is Trading at a Discount