Business development companies, or BDCs, were created in the 1980s by Congress as an investment vehicle that invests in a portfolio of small- and mid-sized companies, mostly private, as a way to spur job growth and help emerging companies grow.
As regulated investment companies, they don't pay corporate taxes on profits, but they are required by law, much like real estate investment trusts (REITs), to pay out at least 90% of their net income in dividends. Because of that requirement, their yields are usually higher than your typical stock, often over 5%. BDCs are popular investments among people looking for passive income, but in this bear market, BDCs are even more popular as investors seek high-yielding dividends to offset big losses in their portfolios.
There are roughly 50 BDC stocks that trade on the market, but because they all invest in different companies and sectors, they are all quite different. Also, because they invest in small, mid-sized, and distressed companies, they can be risky. But here are two that look to be good, safe options right now.
1. Main Street Capital
Main Street Capital (MAIN +0.10%) invests in a portfolio of about 75 different companies, predominantly in the lower middle market -- those with annual revenue in the $10 million to $150 million range. They provide both private debt and private equity and to companies across the spectrum of sectors -- with industrials, energy, information technology, and consumer discretionary having the most representation.
NYSE: MAIN
Key Data Points
Main Street Capital is coming off a strong first quarter where net investment income was up 31% and earnings per share gained 26% year over year. The BDC has generally outperformed its competitors over the years due to its focus on companies with strong competitive advantages, stable cash flow, and seasoned management teams. It also prides itself on its long-term investment focus, relationships with management teams, and one-stop-shop approach to providing capital solutions.
These factors should help it maintain and increase its dividend, as it has for the past 11 straight years. Plus, the rising interest rate environment should boost interest income as 73% of its debt investments have floating rates, said CFO Jesse Morris on the first-quarter earnings call.
As for the dividend, Main Street Capital is a bit unique in that it offers monthly dividend payouts, while most payout quarterly. In June, the BDC declared a supplemental dividend of $0.075 a share, in addition to the regular $0.215 payout. It also approved dividends of $0.215 per share for July, August, and September. That calculates to $2.58 per share for the full year and generates a yield of 6.33%. And as a sign of its safety, Main Street Capital has never reduced its dividend since it went public in 2007.
2. Hercules Capital
Hercules Capital (HTGC 0.79%) is different from Main Street Capital in that its portfolio consists of growth-oriented, venture capital-backed companies, primarily in the technology, life sciences, and renewable technology industries. It currently has a portfolio of 103 companies, with a focus on providing senior secured venture growth loans.
It has been around since 2003 and in that time has committed more than $14 billion to over 570 companies. It is considered one of the leading lenders of entrepreneurs and venture capital firms seeking capital financing. Among those 570 companies was Facebook, now Meta Platforms.
NYSE: HTGC
Key Data Points
Like Main Street Capital, it had a strong first quarter, with net investment income up 3.7%. More importantly, it had record quarterly portfolio growth and record debt and equity commitments, which sets it up for continuing growth. Also, with 94.7% of its portfolio in floating rate fixed-income investments, it stands to generate additional interest income as interest rates rise.
Hercules recently declared a $0.33 per share quarterly dividend in the second quarter, along with a $0.15 supplemental dividend. It pays out a high 9.59% yield with an annual payout of $1.33 per share, not including supplemental dividends. It has increased its dividend for the past four straight years.
These are two well-established BDCs that have developed good track records and reputations within their markets. They should both be pretty safe bets as we head into this rising rate environment.
