Dividends can be a terrific source of passive income for your portfolio. But with so many opportunities out there, it's challenging to identify companies that both pay dividends and consistently perform at a high level.
One good place to source ideas is to look at business development companies (BDCs). BDCs are required to pay 90% of their taxable income to investors in the form of dividends each year.
The three BDCs discussed below could help you turn a $50,000 investment (split equally) into about $5,200 of passive income each year. Let's dig into what makes these BDCs stand out from the pack.
Hercules Capital: Dividend yield 10.5%
Hercules Capital (HTGC 0.63%) is a BDC that invests in technology, life sciences, and sustainable energy businesses. The company typically supports start-ups that have raised funding from venture capital or private equity firms and are looking to augment the balance sheet with some debt.
You might be wondering what makes Hercules stand out from a traditional bank. Well, banks may pass on making loans to start-ups given their risk profile as money-burning businesses. To mitigate this risk, Hercules typically will add sweeteners to its deal structures in the form of warrants that can convert into equity -- thereby providing Hercules with some upside in the event that the company gets acquired or goes public.
This approach appears to be working. During the last decade, Hercules stock had a total return of 235%. By allocating the first one-third of the proposed $50,000 to Hercules, you could earn about $1,750 of passive income this year. Now could be a great time to scoop up some shares of Hercules stock at a juicy 10.5% dividend yield.
Horizon Technology Finance: Dividend yield 11.4%
In the world of technology-focused BDCs, Horizon Technology Finance (HRZN 0.95%) is one of the closest peers to Hercules.
Horizon lends capital to companies looking for additional cash runway, or sometimes even helps fund acquisitions. What can make debt an optimal solution in fundraising is that, unlike equity, it doesn't dilute existing shareholders.
This provides business owners with an extra layer of flexibility because debt providers -- unlike equity investors -- rarely take board seats or have an influence over the strategic vision of the company.
These differentiating features have helped Horizon stand out in a crowded BDC landscape. The stock currently trades at a price-to-book ratio of 1.2, slightly above its 10-year average of 1.
But with a sizzling 11.4% yield, scooping up shares in Horizon looks tempting. Allocating the second tranche of the proposed $50,000 investment could generate $1,900 of dividend income.
Image source: Getty Images.
Ares Capital: Dividend yield 9.2%
The final BDC on my list is Ares Capital (ARCC 0.73%). Ares is quite different from Hercules and Horizon. Instead of focusing on high-growth start-ups, Ares typically looks at lower middle-market businesses.
This is an interesting strategy, and has helped Ares earn a positive reputation among businesses that often go overlooked by large investment banks. Furthermore, given its size, Ares has the financial horsepower to do more complex transactions than other BDCs.
For instance, Hercules and Horizon usually offer revolving or term loans. By contrast, Ares has the ability to complete much more sophisticated deals, including leveraged buyouts.
One other unique feature of Ares is that it has attracted the attention of Warren Buffett. He owns a position in Ares in his secret portfolio -- through New England Asset Management.
ARCC Total Return Level data by YCharts
Given Ares' performance compared to the S&P 500 thematic exchange-traded funds in the chart above, it's easy to see why investors love this stock.
The last one-third of the proposed $50,000 investment in Ares would generate roughly $1,540 of dividend income -- bringing your total passive income to about $5,200.
