In December of last year, I wrote that I expected to see Prospect Capital Corporation (NASDAQ:PSEC) generate returns of 40% or more over the course of 2015.
Well, as we near the end of the first quarter, we have a little catching up to do. Prospect Capital is sitting on gains of about 4%. That’s beating the S&P 500 year to date, but it’s certainly nothing to write home about. Meanwhile, one of my competitors, Rave Restaurant Group Inc (NASDAQ:RAVE), is already up 116% and another, Ambarella Inc (NASDAQ:AMBA), is up 43%.
Up against competition like that, it is time to throw in the towel?
Absolutely not.
With more than nine months left in the year, Prospect Capital is still very much in the running.
To start, Rave Restaurant Group is a microcap stock, and Ambarella is a volatile, high-beta stock. I consider it very likely that one—or both—of these stocks crashes and burns long before year end.
I’m a little more concerned about Louis Navellier’s pick this year, Apple Inc (NASDAQ:AAPL) I myself am long Apple and consider it a worthy competitor. But as much as I like Apple as a long-term holding, I consider Prospect Capital the better buy in 2015.
Let’s take a look Prospect’s recent developments. Prospect had a lackluster earnings release last month, with EPS coming in at 24 cents per share rather than the 28 cents Wall Street expected.
But the far more important news in the earnings release was that book value remained stable. Net asset value per share was $10.35, a decline of 38 cents from the previous year. But substantially all of this decline was due to Prospect’s large dividend, which for much of 2014 was well in excess of current earnings. With the turbulence in the energy sector, there were concerns that Prospect might have some significant write-downs. Thus far, this has proven to not be the case.
This is a big deal because I specifically mentioned Prospect’s large discount to book value as a major reason to own the stock. If Prospect’s book value had seen serious deterioration, it would have blown a hole in my bullish argument. At year end, Prospect was trading at 80 cents on the dollar. Today, that valuation has crept up to 83 cents on the dollar.
That’s still ridiculously cheap. I don’t know about you, but I don’t come across too many 83-cent dollars, so I tend to pick them up when I find them.
Now let’s talk dividends. Prospect Capital slashed its dividend last year, which is a major reason why investors are so sanguine towards the stock these days. To many investors, a dividend cut is a breach of trust, and that is not always easy to mend. But in Prospect Capital’s case, it was the right move. As management de-risked Prospect’s balance sheet last year, the lower-risk, lower-return Prospect was not able to sustain its dividend at the current level. Today’s 8.33-cent monthly dividend is far more sustainable.
It also equates to a 12% yield at current prices. And 12% yields aren’t particularly easy to come by these days.
So, what sort of returns should we expect from here? A return to book value—which I believe is warranted—would add about 20% in capital gains. Add to that about 1% per month in dividends, and we get another 9% for a total of 29%. Add to that the 4% we’re already returned thus far, and we’re looking at 33%. And we could see returns significantly better than that if we see a special dividend or if Prospect trades at a premium to its book value—as it has for much of its life.
Is that a recipe for 100% gains in a single year? No, of course not. But it’s still a lot better than I expect the S&P 500 to produce over the next 2-3 years. And I expect that come December 31, it will be enough to make Prospect Capital the Best Stocks for 2015 winner.
Editor's Note: This article is an update to the Best Stocks for 2015 contest.