This Robinhood Stock Has a Trailing 48% Dividend Yield. Is It Too Good to Be True?

The popular online brokerage Robinhood offers several filters for investors looking for interesting stocks, including one for dividend yield, which compares a company's annual dividend to its share price. This essentially tells investors how much they will earn in dividends based on how much they pay for a share. If an investor buys one share for $100 that pays an annual dividend of $3, the dividend yield is 3%.

One of the highest dividend yields on Robinhood's screener was for a closed-end investment company called Oxford Lane Capital (NASDAQ: OXLC), which has a trailing-12-month dividend yield of about 48%, an astounding figure well above the norm. Is a dividend yield like this simply too good to be true?

The complex world of private credit

If you follow markets, then you've probably heard about private credit. After the Great Recession of 2007-2009, lawmakers passed sweeping bank regulations to make the banking system safer and less vulnerable to another meltdown. Although the regulation succeeded on this front, further regulation also stymied bank lending, which opened the world to private credit.

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Private credit typically involves non-bank institutions, such as private equity firms and asset managers, offering various types of loans to companies that may not be able to obtain bank funding or may prefer the terms offered by private credit. The main concern about private credit, which has grown exponentially, is that it is not heavily regulated and therefore much more opaque than the banking sector, posing risks to the broader market.

Oxford Lane Capital is a registered closed-end investment management company, which means it issues a limited number of shares to raise capital that it invests at its discretion. The company also charges a 2% management fee. Furthermore, Oxford Lane is a regulated investment company, meaning it can avoid corporate taxes if it distributes 90% of its taxable income each year to shareholders, which is why it typically has a high dividend yield.

Oxford Lane operates more on the fringes of private credit, as it does not directly make loans. Rather, the fund invests in collateralized loan obligations (CLOs) backed by senior secured loans issued to companies with either unrated or junk-rated debt. Specifically, Oxford mainly invests in the equity tranche of CLOs but will also invest in CLO debt through subordinated or unsecured loans.

Is the dividend yield too good to be true?

The short answer is yes. In fact, Oxford Lane announced on its most recent earnings call that it will cut its dividend in half starting in April. Management attributed the reasoning to preserving capital in order to take advantage of opportunities in the secondary CLO market.

However, the company and stock have certainly been struggling, which typically pushes up the dividend yield. The stock is down 57% during the past year, and the company also conducted a reverse stock split in September, which typically isn't a great sign for shareholders. In Oxford Lane's most recent quarter, net asset value (NAV), or equity, fell by 19% to $15.51 per share. This is because the company experienced net depreciation unrealized losses of more than $305 million, representing the markdown of the company's portfolio in the quarter.

Oxford Lane is built for a high-risk, high-reward investor. The equity portion of the CLO is typically the most risky because the other tranches are paid first, so if there are losses in a CLO, the equity tranche will bear the burden. The upside is the ability to not only receive distributions but also excess cash flows from the loan portfolio once all of the CLO's debt obligations are paid.

Oxford Lane's CLO investments are also collateralized by loans to companies with a junk rating on their debt, making the collateral risky as well. Now, Oxford Lane's stock price currently trades for much less than its NAV, and the net depreciation losses are unrealized, meaning the company may be able to recoup them if CLO market conditions improve. The new forward dividend yield is also still quite high at close to 22%.

However, I think this is going to be a volatile investment and quite difficult for retail investors to analyze, given the unknowns in private credit. I would avoid Oxford Lane unless you're truly a sophisticated investor with greater industry knowledge.

Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.