If you're seeking passive income from your investment portfolio, Hercules Capital (HTGC 0.81%) is one stock that may have caught your attention. Hercules Capital invests in venture-backed start-ups, and offers an ultra-high dividend payout of over 10% annually.
However, if you're considering adding Hercules Capital for its passive income potential, there are some things you should know first.
Hercules Capital is an ultra-high-yielding company that invests in start-ups
Hercules Capital is a specialty non-bank lender that invests in fast-growing start-ups in technology, life sciences, and renewable energy. The company is a business development corporation (BDC), meaning it provides companies with funding in their early stages of growth.
The benefit of investing in BDCs is that investors can gain exposure to private equity-type investments while collecting a hefty dividend payout along the way. The large dividend payout is a product of the company's tax structure. Most BDCs are registered investment companies (RIC), meaning they must distribute 90% of their income to investors to be exempt from federal taxes.
Most of Hercules's assets are in debts structured with warrants, equity, and options, giving the company a way to benefit from the upside results of those companies that it invests in. According to the company, over 250 of its portfolio companies have gone public through an initial public offering (IPO), merged, or were acquired since its inception. Over the years, some of Hercules's investments have included Palantir Technologies, ChargePoint, FuelCell Energy, and Lyft.
HTGC Dividend data by YCharts.
Hercules's most recent quarterly dividend payment of $0.40 per share gives it a dividend yield of 8.4% based on its stock price today. However, the company also issued a supplemental dividend of $0.08 per share in the quarter. It does this because the value of its assets can be unpredictable, so this supplemental payout can fluctuate widely. Combined, the two payouts give Hercules a payout of over 10%, which is in line with its average payout over the past decade.
Consider these key metrics when investing in BDCs
Investing in BDCs isn't without risk. Lending to small, up-and-coming companies is inherently risky. On top of that, BDCs use leverage to boost their payouts to shareholders. While this can boost performance during good times, it also magnifies losses in a poor economic environment.
The debt-to-equity ratio is one metric that shows how much leverage BDCs use. Hercules Capital's debt-to-equity ratio is 0.75, well below the BDC average of 1.08, showing that the company's leverage is quite conservative relative to its peers.
In addition, 89% of Hercules's investments are in first-lien senior secured debt. This type of debt holds the highest priority claim on a borrower's assets if there is a default or bankruptcy, and is considered safer than subordinate debt below it.
A pullback in bank lending creates opportunities for Hercules Capital
One thing that has benefited BDCs over the past few decades has been the pullback in bank lending to small and medium-sized companies. According to data from Pitch Book, banks went from around a 70% share of the middle market direct lending market in 1994 to around 25% in 2022.
Image source: Getty Images.
In addition, the failure of Silicon Valley Bank (an SVB Financial subsidiary) left a big hole in lending for venture capital and other start-ups. Last year, Hercules stepped up to provide capital for companies that needed to meet financing and other short-term obligations when Silicon Valley Bank went under.
Hercules Capital got stronger as a result. Last year, the company grew its investment portfolio by nearly 10% and raked in $304 million in net investment income (NII), representing a 62% increase year over year.
Is it a buy?
Hercules Capital has been a solid dividend stock for investors, navigating multiple recessions since its IPO in 2005. The nature of its business, with its customer base, could expose the stock to more volatility. However, its high upside potential from investing in start-ups and a stellar dividend yield of over 10% make it a solid income stock to consider adding today, especially for investors who are relatively risk tolerant.
