There are many different ways to add growth to your portfolio. For some, investing in companies taking advantage of emerging trends, such as artificial intelligence (AI), can be lucrative.
However, this approach requires investors to speculate about which companies are best positioned to win long term. This can require lots of effort when it comes to performing due diligence, and there's always the risk that you could be wrong.
A more passive strategy to augment your portfolio can be adding dividend stocks. While many companies pay dividends, business development companies (BDCs) represent a unique and potentially lower-risk way of adding substantial passive income to your portfolio. Why? Because BDCs are required to pay out at least 90% of their taxable income to shareholders each year.
The three BDCs outlined below each carry an ultra-juicy dividend yield of roughly 10%. Investing $100,000 (split evenly) across these three leading BDCs could add $10,000 of dividend income to your portfolio this year. Let's dig into why these particular BDCs represent a good buying opportunity for investors.
Hercules Capital: 10.3% dividend yield
Hercules Capital (HTGC +1.13%) is a BDC that focuses on technology, life sciences, and sustainable energy businesses. It specializes in an investment vehicle called venture debt.
Typically, a start-up will raise funds during its early days from venture capitalists (VC) or private-equity firms. In exchange for capital, founders will give up equity in their company. As the start-up matures, this form of capital raising becomes less attractive to founders, due to the dilutive impact that comes with giving up equity ownership.
Founders seeking capital may eventually look for a loan since debt doesn't come attached to any ownership share of the company. This is where Hercules can add value.
Unlike a traditional bank that may pass on a start-up due to its risk profile, Hercules specializes in term loans and other debt structures for venture-backed companies. However, the catch is that this debt typically carries a much higher interest rate than a loan from a bank.
What makes Hercules even more special is how it structures deals. Hercules typically adds warrants to its deals, giving it the ability to receive shares and profit from an initial public offering (IPO) or an acquisition of one of its portfolio companies.
During the past 10 years, Hercules has a total return of 218%. Not only does this underscore the importance and power of reinvesting dividends, but it specifically highlights how strong Hercules has performed over a long-term time horizon.
While the company's current price-to-book (P/B) of 1.6 is modestly higher than its 10-year average, the premium is warranted, given Hercules' leading position in the world of BDCs. Furthermore, amid the rising demand surrounding artificial intelligence (AI), green energy, and biotech, Hercules is extremely well-positioned to benefit from secular tailwinds because many of its portfolio companies operate within these sectors.
With Hercules's dividend yield of 10.3%, the first one-third of the proposed $100,000 investment could yield $3,433 of dividend income for your portfolio.
Image source: Getty Images
NYSE: HTGC
Key Data Points
Horizon Technology Finance: 10% dividend yield
One of Hercules's biggest rivals is Horizon Technology Finance (HRZN 0.11%). Over the past decade, this company's stock has returned 152% to investors (with dividends reinvested).
The generous stock returns could suggest that Horizon has done a stellar job consistently working with strong, reliable growth companies in emerging markets. But while the stock is a multibagger, it isn't exactly cheap right now.
Horizon's P/B ratio of 1.2 is a bit higher than its 10-year average. Even so, the company has been a reliable dividend payer for years, and the company operates across many different growth markets.
For investors looking to supplement their portfolios with some reliable passive income, Horizon Technology represents a proven high performer. With the company's dividend yield of 10%, the second one-third of the proposed $100,000 investment could yield $3,333 of dividend income for your portfolio.
Ares Capital: 9.6% dividend yield
The last BDC on my list is Ares Capital (ARCC 0.10%). Unlike Hercules and Horizon, Ares typically invests in lower-middle-market businesses across a variety of sectors. This is an interesting approach because Ares tends to work with businesses that may be perceived as too risky for other BDCs or may not fit the ideal client profile for an investment bank.
Ares can work with these businesses because the company has a strong balance sheet and offers a number of flexible solutions to fit the needs of its clients. While Hercules and Horizon tend to specialize in revolvers or term loans, Ares has the size and expertise to complete more complex transaction types, such as leveraged buyouts.
At a P/B of 1.05, Ares is trading right in line with its 10-year average. And yet, for the last few years, Ares stock has crushed a number of S&P 500-themed exchange-traded funds (ETF).
Given its muted valuation profile relative to other BDCs, Ares could represent an under-the-radar opportunity for dividend investors. With a dividend yield of 9.6%, the final one-third of the proposed $100,000 investment could yield $3,200 of dividend income for your portfolio.
