TPVG - Buffett Is Bold On Big Dividends And The American Dream

2023-08-18 07:35:00 ET

Summary

• Warren Buffett has built an empire seeking opportunities across the board.
• Small- and mid-size businesses define the spirit of the American dream.
• +10% yield from adopting the Income Method to invest in the heartbeat of the American economy.

Co-authored with “Hidden Opportunities.”

From the boardrooms of blue-chip corporations to the seminar halls of leading business schools, Warren Buffett’s investing principles continue to teach, inspire, and stimulate intense debates.

Everyone talks about Mr. Buffett’s success with Coca-Cola ( KO ), American Express ( AXP ), McDonald's ( MCD ), and other mega-cap companies. But little about the Oracle of Omaha’s success with locally owned businesses and turn-around opportunities is discussed. In his 80+ year investing career, Mr. Buffett’s capitalistic vision extended to several small, often niche sectors, including companies struggling to compete or facing bankruptcy proceedings.

Take a look at Berkshire Hathaway's ( BRK.A , BRK.B ) purchase of See’s Candies. Nothing was exciting or newsworthy about this business; sales growth was relatively stagnant.

Another example is the acquisition of Brooks Shoes and Fruit of the Loom, two retail companies that had previously pursued bankruptcy. Berkshire picked them up at good bargains and continued milking the cow until now. Why go so far? Berkshire Hathaway itself was a struggling textile manufacturer facing years of declining operations that the Oracle of Omaha bought to take revenge on its then-CEO for allegedly trying to cheat him. Berkshire's later acquisitions of Duracell and Acme Brick show that Mr. Buffett was highly interested in companies and products that the average person can understand and likely use daily.

Young Buffett had his fair share of hungry acquisitions of companies that catered to the daily needs of the average American. It included companies of all sizes and all financial health. Brand value, moat, balance sheet health, and profitability were all evaluated, but the deals didn’t seek perfect everything to proceed.

"My wealth has come from a combination of living in America, some lucky genes, and compound interest" – Warren Buffett.

We live in a capitalistic society, and Mr. Buffett saw sticky demand for certain goods and services and seized the opportunity by buying entire companies. Those opportunities made sense then, and Berkshire achieved meaningful returns for years. But eventually, some were transformed, shut down, or sold.

I like the idea of investing in small brands and suppliers of critical goods and services. I want to replicate the younger Buffett’s model of building a comprehensive portfolio of widely used and popular goods and services such that it regularly generates profits and cash flow for me to deploy as I see fit.

Today, we will discuss a type of industry that provides a helping hand to small and medium-sized American businesses and generates massive profits from the undertaking.

Introducing BDCs

A Business Development Company ("BDC") is a Regulated Investment Company ("RIC") that follows a business model of borrowing at fixed rates and issuing loans at floating rates. As such, rising interest rates directly benefit their bottom line, and we stand to benefit as shareholders since RICs are required to distribute 90% of their income to avoid taxes. Due to strong tailwinds from the Fed’s economic stance, our income from this sector is strong and growing. We have seen several dividend raises, supplements, and special dividends from our BDC investments.

The BDC Model Has Evolved Since The GFC

Despite concerns over the credit markets, it is important to note that BDCs are much more conservatively managed and operated when compared to the years after the Great Financial Crisis, or GFC. Over the past decade, BDCs have shifted their lending focus to increase exposure to first-lien and senior-secured loans.

Moreover, these companies are getting more selective with their lending strategy, emphasizing more resilient businesses to minimize the risk of default. Among the six largest BDCs, the average client company EBITDA has increased from $61 million in 2016 to $75.5 million in 2019. Source .

A High-Yield ETF To Access This Attractive Sector

VanEck BDC Income ETF ( BIZD ) maintains a portfolio of 26 holdings, with composition determined by the size of the BDC. The big three in this sector – Ares Capital ( ARCC ), FS KKR Capital Corp ( FSK ), and Blue Owl Capital Corp ( OBDC ) – represent ~44% of the total portfolio and reported stellar earnings in Q2 2023.

ARCC is typically considered the bellwether among BDCs. In Q2, ARCC produced NII of $0.57, covering its $0.48 by 119%. ARCC earned the same amount as Q2 2022 while decreasing leverage from 1.24x to 1.07x.

FSK reported Q2 adjusted net investment income of $0.78/share, providing adequate coverage for its $0.64 regular dividend and $0.06 supplemental dividend. FSK notably reported a rise in weighted average debt portfolio yield due to tailwinds from higher interest rates.

OBDC beat analyst expectations and reported a $0.48/share NII that led to the board declaring a $0.07/share supplemental dividend. The total $0.4/share dividend enjoys adequate coverage, and the BDC has been making excellent progress with its share repurchases. Source .

The ETF’s exposure to more growth-oriented and specialty financing, such as SLR Investment Corp ( SLRC ) and TriplePoint Venture Growth ( TPVG ), is very limited at 1.6% and 0.9%, respectively. This indicates the ETF’s higher composition to bigger and more stable BDCs provides greater income stability and adequate portfolio diversification across the small & mid-sized business credit landscape.

Expense Ratio Demystified

BIZD is a Fund of Funds ("FOF"), as it is an exchange-traded fund, or ETF, composed of individual BDCs that are themselves managed funds. Many BDCs are externally managed, requiring the entity to pay the management team based on agreed-upon compensation plans. FOFs are required by the SEC to report a total expense ratio on the prospectus, including the expense ratios of the underlying funds. Source .

There is a component called the Acquired Fund Fees and Expenses ("AFFE") which are indirect expenses not borne by the Fund. They do not reflect expense information on BIZD’s financial statements. The only expense off the BIZD income statement is the 0.41% management fee. We recommend reviewing this write-up about AFFE if the concept is still unclear.

Dividend Strategy

BIZD pays variable dividends depending on its income generation from portfolio BDCs. BIZD’s TTM dividends indicate a healthy 10.8% yield. Despite the variability, BIZD has maintained a fairly stable payment bracket since its inception.

Conclusion

As you read this, you may be eager to scroll down and comment, saying Buffett will never invest in these. Let me state the obvious – Berkshire will not buy BIZD or any BDC as such. Not only are these too small for BRK.B to consider, but it would be pretty redundant as the conglomerate already has several operating subsidiaries that offer various products and services to a wide range of American businesses.

I encourage you to review the history of Berkshire Hathaway. You may be dazed by older Buffett's charisma and celebrity personality in his interviews and conferences, recommending index funds while sitting on hundreds of billions in cash. But note that the actual wealth-building happened decades ago when Mr. Buffett was the card-carrying capitalist, seeking opportunities from every fabric that built and grew this nation. If growing wealth is your objective, I encourage you to study his younger self's hunger for acquiring small or struggling American businesses by tapping into the brand value, moat, and cash flow potential.

"Our economy is a wonderful engine of prosperity. It will continue to work, and it will work very well. The U.S. capitalist economy creates value over the long term." – Warren Buffett.

Berkshire Hathaway doesn't pay dividends but collects them with both hands from its investments and operating subsidiaries. So Grandpa Buffett likes to dip his beak into the profits of prosperous businesses but wants his shareholders to time the market and sell shares for income. This is why BRK.B doesn't suit my income goals. We replicate The Oracle of Omaha’s hunger for profits and his thirst for cash flow in ways that fit our needs.

BDCs specialize in providing financial support, strategic guidance, and advisory support, amongst many other assistive measures, to small and medium-sized businesses, representing the heartbeat of the American economy. High-quality, well-managed BDCs are well-positioned to maintain their income generation and dividend payability through interest rate cycles and recessions. Corporate America is the best place to be invested for long-term success, and BIZD gives you the BDC basket of goodies and offers an attractive 10.8% yield for your investment.

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