Good Value for Your Money?
For value-conscious income investors, few things are better than a high-yield stock trading at a significant discount.
Think about it: at any given cash dividend rate, the higher the stock price, the lower the yield you can lock in. Therefore, as stocks shot through the roof for the most part of the last decade, dividend yields have gotten suppressed.
And that’s why CM Finance Inc (NASDAQ:CMFN) is special. The company offers a double-digit annual dividend yield and is trading at a sizable discount to its net asset value. Allow me to explain.
CM Finance Inc is a closed-end investment company. Headquartered in New York City, it provides financing solutions to middle-market businesses in the U.S.
Because middle-market companies can’t always get loans from banks, they have to pay higher financing costs. And that has translated to a tidy interest income stream for middle-market lenders like CM Finance. As of December 31, 2017, the weighted average yield on CM Finance’s debt investments at cost was 10.25%. (Source: “CM Finance Inc Reports Results for its Fiscal Second Quarter ended December 31, 2017,” CM Finance Inc, February 7, 2018.)
And due to the fact that CM Finance chooses to be taxed as a business development company (BDC), it must return at least 90% of its profits to shareholders through regular dividend payments.
With a quarterly dividend rate of $0.25 per share, CMFN stock offers an annual yield of 12.4% at the current price.
The dividend is also safe. In the December quarter, CM Finance generated net investment income of $0.27 per share, which was more than enough to cover its quarterly cash dividend of $0.25 per share.
For those worried about the risk associated with lending to smaller companies, note that CM Finance doesn’t really invest in startups. In fact, the company only lends to businesses with annual revenues of at least $50.0 million and earnings before interest, tax, depreciation, and amortization (EBITDA) of at least $15.0 million.
Moreover, the company focuses on making senior secured loans, meaning the borrowers have to pledge some assets as collateral. By the end of 2017, first- and second-lien loans accounted for 95% of CM Finance’s portfolio at fair value. This means if the borrower defaults, CM Finance will be either the first or second one in line to get paid. (Source: “CMFN Investor Presentation,” CM Finance Inc, December 31, 2017.)
The portfolio is also quite diversified. CM Finance has investments in 24 companies from 13 different industries. The company’s largest industry exposure, business services, only accounts for 24% of its portfolio.
Another thing to note is that, by the end of 2017, 96.2% of CM Finance’s debt investments bore interest at floating rates. This means, if interest rates increase—which the market is currently anticipating—the company will likely generate higher interest income from its debt investments. (Source: “Form 10-Q,” United States Securities and Exchange Commission, last accessed March 22, 2018.)
Best of all, in the December quarter, CM Finance’s net asset value increased 0.9% sequentially to $12.50 per share. And yet CMFN stock trades at just $8.05 apiece. So, if the company’s net asset value hasn’t changed much in the last three months, investors would be buying CMFN shares at a 35% discount at the current price.