The stock markets have gotten off to a red-hot start in 2024. Both the S&P 500 and Nasdaq Composite have reached record levels, thanks mostly to megacap tech companies leading the charge in artificial intelligence (AI).
AI certainly represents a compelling growth market at the moment. However, investors can supplement their portfolios with other opportunities, as well. One reliable source of growth can be found in dividend stocks.
In particular, business development companies (BDCs) are a unique source of passive income because they're required to pay 90% of their taxable income each year to investors. Let's break down three leading BDCs that could help fuel further gains in your portfolio.
NASDAQ: ARCC
Key Data Points
1. Hercules Capital: 10.4% dividend yield
Hercules Capital (HTGC 0.44%) is a leading BDC for technology, life sciences, and sustainable energy businesses. It specializes in an investment vehicle called venture debt.
Generally, in the early stages of building a start-up, a company needs to raise funds from venture capital or private equity firms. As the company matures, however, raising additional equity becomes less optimal for founders because of the dilution that occurs.
This is where Hercules stands out. Debt is non-dilutive -- so it won't reduce the equity holdings of founders and employees. Moreover, Hercules typically writes larger checks, compared to a typical bank.
The catch is that to account for this risk, the interest on Hercules's term loans is much higher. Furthermore, the BDC generally includes warrants convertible into equity in its deals -- providing it with an extra sweetener should one of its borrowers get acquired or pursue an initial public offering (IPO).
HTGC Total Return Level data by YCharts.
During the past 10 years, Hercules stock has had a total return of 270%. Not only does this showcase the company's superior investment prospects, but it also underscores the importance of reinvesting dividends.
With Hercules' juicy dividend yield of 10.4%, now looks like an incredible opportunity to scoop up shares in this leading BDC.
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2. Horizon Technology Finance Corporation: 11.7% dividend yield
Horizon Technology (HRZN 2.19%) is a major competitor to Hercules. The company also specializes in high-yield loans to venture-capital-backed start-ups in technology, energy, and healthcare. While its total return of 147% over the last decade doesn't stack up to Hercules', I'd say it isn't too shabby.
HRZN Price to Book Value data by YCharts.
Moreover, Horizon's price-to-book (P/B) ratio of about 1.2 is significantly lower than Hercules's P/B. Each company is a leading BDC among start-ups, but the disparity in valuation multiples pictured above could signal that Horizon represents a better value at the moment.
With a sizzling yield of 11.7%, Horizon is tough to pass over. This could be a solid opportunity to complement other dividend investments in your portfolio right now.
3. Ares Capital: 9.4% dividend yield
The last BDC on my list is Ares Capital (ARCC +0.48%). Ares is actually quite different from Hercules and Horizon.
The company tends to focus on lower-middle-market companies across a wide array of industry sectors. In essence, Ares has carved out a unique little niche within the BDC realm. The company works with businesses that may be seen as too risky or not attractive enough to work with a traditional investment bank.
However, Ares's large balance sheet and astute approach to due diligence provide the company with a high degree of financial flexibility. As such, Ares can offer a range of more sophisticated financial solutions compared to other BDCs, including leveraged buyouts (LBO).
ARCC Total Return Price data by YCharts.
One of the most attractive aspects of Ares is that the company has consistently outperformed some of the leading exchange-traded funds (ETFs) over the last few years. As seen above, an investment in Ares has crushed S&P 500-focused ETFs such as the SPDR S&P 500 ETF Trust, Invesco S&P 500 Equal Weight ETF, and Vanguard S&P 500 ETF.
Ares has a rewarding historical record and it offers a differentiating business model from other BDCs. As a result, now could be a great opportunity to scoop up shares at a yield of more than 9%.
