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Gladstone Investment: Why I Sold This 6.8%-Yielding BDC

Investors in business development company Gladstone Investment Corp. (GAIN) may want to think about taking some profits after a strong increase in share price in 2019. I have now closed my long position in GAIN in light of the sharp increase in price and improvement in investor sentiment. Both valuation and risk/reward-ratio are no longer attractive, in my opinion. This article serves as a valuation and action update to a previously published investment thesis.

Strong Recovery

You may remember that I penned a piece on Gladstone Investment Corp. in the summer of last year titled "Wait For A Drop Before Buying This 6.9%-Yielding, Monthly-Paying BDC," in which I recommended investors to wait for a correction before scooping up some shares (GAIN was trading at about $12 at the time). I wrote:

Gladstone Investment Corp.'s shares don't have an attractive risk-reward right now: The BDC doesn't have very good dividend coverage stats (low margin of dividend safety) and shares sell for a premium to book value. Though shares are no longer overbought and have interest rate upside, I'd wait for a drop towards $10 before gobbling up a few shares for my high-yield income portfolio.

Later in 2018, I opened up a speculative long position in Gladstone Investment Corp. when shares dropped back to the $10 price level. Today, however, the share price has rebounded to $12.

Gladstone Investment Corp.'s share price has bounced back hard from the December sell-off, gaining a whopping 28.4 percent this year. If you indeed bought at the $10 price level, you are already sitting on significant capital gains - and smart investors may want to take some chips off the table after Gladstone Investment Corp.'s share price exploded higher.

According to the Relative Strength Index, or RSI, which flashes a value of 79.75, Gladstone Investment Corp. is WIDELY overbought, which in turn exposes investors to considerable downside risks.

The recovery, though, has been stunning.

See for yourself.

Source: StockCharts

Gladstone Investment Corp. - Portfolio Snapshot

Gladstone Investment Corp. is structured as a business development company which means it must distribute the majority of its earnings/taxable income as dividends. Hence, Gladstone Investment Corp. is a yield investment, first and foremost.

Gladstone Investment Corp. predominantly invests in secured first lien debt (54.4 percent) and secured second lien debt (12.2 percent). The remainder is made up of common and preferred stock investments (33.4 percent).

Here's a portfolio breakdown by investment type at the end of the December quarter.

Source: Gladstone Investment Corp. 10-Q SEC Filing

The equity component in Gladstone Investment Corp.'s investment portfolio is noteworthy because:

  1. 1. It is significant in size and value relative to other BDCs (most BDCs have much more defensively structured debt-focused investment portfolios), and
  2. 2. It provides GAIN with considerable upside potential.

Gladstone Investment Corp. has been able to boost shareholder returns in the past through successful exits from equity investments.

Source: Gladstone Investment Corp. Investor Presentation

Most Recent Financial Performance

Gladstone Investment Corp. released results for its third fiscal quarter (quarter ending in December) at the beginning of February.

The business development company earned $15.0 million in total investment income in the last quarter compared to $13.1 million in the previous quarter. Net investment income - a key measure for BDCs - hit $6.0 million compared to a loss of $4.0 million in the September quarter.

On a per-share basis, Gladstone Investment Corp. earned $0.24 in adjusted net investment income compared to $0.10/share in the previous quarter. Importantly, the BDC earned its full cumulative recurring quarterly dividend payout of $0.204/share in the December quarter with adjusted NII.

Here's an earnings snapshot.

Source: Gladstone Investment Corp. Earnings Release

Book Value Growth

Gladstone Investment Corp.'s net asset value increased from $12.30/share in the September quarter to $12.53/share at the end of December, reflecting an increase of $0.23/share, or 1.9 percent quarter over quarter.

Gladstone Investment Corp.'s net asset value has slowly but steadily increased over time, indicating a healthily growing investment business.

ChartData by YCharts

Outperformance

Gladstone Investment Corp. has outperformed its BDC peers in terms of returns on equity and stock market performance over a 1, 3, and 5-year period.

See for yourself.

Source: Gladstone Investment Corp.

Taking Profits Is The Smart Thing To Do

After a strong increase in price - without a change in Gladstone Investment Corp.'s fundamentals in the last two, three months - the smart thing to do is to scale back the investment and take some profits before investor sentiment inevitably swings back into neutral or even oversold territory.

Now Gladstone Investment Corp.'s core investment thesis remains intact, though: The company about covers its dividend with (adjusted) net investment income, and the dividend is sustainable, as I explained in my last article. However, the valuation and the risk/reward are just no longer appealing enough to justify the opening of a NEW position in GAIN, in my opinion.

Gladstone Investment Corp.'s NAV discount has significantly narrowed from 15 percent to 4 percent since I last recommended the BDC to buy in October 2018.

ChartData by YCharts

Your Takeaway

Gladstone Investment Corp.'s shares have rallied almost 30 percent this year which makes this a great time to sell into the strength. I recommended GAIN when shares were trading @$10, out-of-favor, oversold, and priced at a larger NAV-discount. Today, shares are overbought, fully valued (tiny discount to NAV), and once again sell for $12. Taking profits is the smart thing to do. I will consider re-buying GAIN at the $10 price level during the next market rout.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.