A High-Yield Stock You Likely Haven’t Considered
Most people have never heard of CM Finance Inc (NASDAQ:CMFN), but the company provides one of the biggest yields in the current stock market.
You see, for the most part of the last decade, U.S. equities enjoyed a strong bull market. However, because dividend yield moves inversely to share price, a prolonged bull market means now is not exactly the best time for income investors.
Consider this: historically, the S&P 500 Index has had an average dividend yield of 4.36%. Today, the number stands at just 1.87%, meaning if an investor puts $100,000 in an S&P 500 portfolio, they would collect just $1,870 in annual dividends. (Source: “S&P 500 Dividend Yield,” Multpl.com, last accessed April 16, 2018.)
A less-than-two-percent cash yield is certainly not enough for most income investors. Fortunately, even in today’s bloated market, there are still companies offering much more substantial payouts. CM Finance Inc, for instance, pays quarterly dividends of $0.25 per share, which comes out to an annual yield of 12.6%.
Of course, one of the reasons why companies have high dividend yields is that investors don’t believe the payout to be sustainable. And for income investors with a long-term horizon, few things are worse than a dividend cut.
Therefore, the big question now is, is CM Finance stock’s payout safe?
Well, to answer that question, let’s first take a look at how the company makes money.
Headquartered in New York City, CM Finance is a closed-end investment company that focuses primarily on the U.S. middle market. While middle-market businesses are known to be less established than large-cap ones, CM Finance is not investing in startups. In fact, its target portfolio companies tend to have annual revenues of at least $50.0 million and earnings before interest, tax, depreciation, and amortization of at least $15.0 million.
To put it simply, CM Finance is in the lending business. It provides debt financing to middle-market companies and earns a steady stream of interest income. As of December 31, 2017, CM Finance’s debt investments had a weighted average yield of 10.25%. (Source: “CM Finance Inc,” CM Finance Inc, last accessed April 16, 2018.)
High-yield debt is not exactly the safest type of investment. But the company has put in a lot of effort managing its risk. First, the portfolio is well-diversified. As of the end of 2017, CM Finance has investments in 24 companies from 13 different industries. The company’s largest industry concentration, business services, represents less than one-quarter of its total portfolio.
At the same time, CM Finance also diversifies geographically across seven different regions. No single region accounts for more than 28% of the company’s portfolio fair value. Through diversification, CM Finance makes sure that even if one industry or one region enters a downturn, the impact on company-level financials would likely be limited.
Here’s the best part: even though high-yield debt does not have the best reputation when it comes to income safety, CM Finance invests primarily in senior secured loans. By the end of last year, first-lien debt represented 50.1% of the company’s portfolio. As a first-lien lender, CM Finance will stand first in line to get paid in the event of a default.
Meanwhile, another 44.9% of the company’s portfolio was made up of second-lien debt. With 95% of its portfolio invested in first- and second-lien loans, CM Finance has a much better risk profile than lenders that focus on subordinate loans.
Business has been going quite well at this middle-market investment company. In the fourth quarter of 2017, CM Finance generated net investment income of $0.27 per share, while its net assets increased by $0.35 per share from operations. Whichever metric you use, the company earned more than enough money to cover its quarterly dividend rate of $0.25 per share. (Source: “CM Finance Inc Reports Results for its Fiscal Second Quarter ended December 31, 2017,” CM Finance Inc, February 7, 2018.)
At the end of the day, conservative income investors would probably want to see a wider margin of safety in the company’s payout ratio. But note that CM Finance is structured as a business development company (BDC), meaning it is required by law to distribute at least 90% of its profits to shareholders through regular dividend payments. Therefore, higher payout ratios are common among BDCs.
As it stands, CM Finance’s 12.6% yield could be an opportunity.