One of the best ways to bolster your portfolio is to supplement growth opportunities with dividend stocks.
While there are many dividend stocks out there, some of my favorite opportunities are in business development companies (BDC).
Let's analyze two unique players in the BDC space and look at how each has been a top-performing stock for investors.
1. Hercules Technology Growth Capital: 9.1% dividend yield
Hercules Technology Growth Capital(NYSE: HTGC) is a BDC that specializes in making high-yield loans to emerging technology businesses.
During the early days of a start-up, founders will initially look to venture capital (VC) investors to help raise funds. The opportunity cost of these transactions is that founders give up equity ownership in exchange for capital from investors. Eventually, this dilutive structure becomes less attractive, and the founders will entertain alternative sources of financing.
Hercules offers a mixture of venture debt vehicles -- typically term loans or revolvers that are used for growth capital or acquisition financing. The difference between Hercules and a typical bank is that it has a higher appetite for risk. This means that Hercules will usually write a bigger check than a small bank, but the trade-off is that the loan carries a significantly high coupon rate to account for this assumed risk.
One other aspect that I like about Hercules' deal structure is that the company often negotiates for warrants. Therefore, Hercules not only generates steady income from its principal and interest payments but it also can benefit from the upside of a liquidity event in its portfolio companies.
Of course, while all of this sounds great, there are some risks investors need to be aware of. In particular, many of the businesses that Hercules loans to are still in growth mode. This means that many of them are not yet generating steady, predictable revenue, which can lead to inconsistent cash flow generation. The obvious risk here is that companies could struggle to pay back their loans.
According to Hercules' first-quarter financial reporting, only 1.2% of its entire portfolio is categorized as non-accrual status -- meaning that principal and interest payments will likely not be collected under the initial contractual terms. Considering the Hercules portfolio is worth $3.6 billion, I don't see its non-accruals as a material risk at present. It would take a significant deterioration in its non-accruing loans to make a big dent.
Considering the stock has outperformed the S&P 500 on a total return basis over the last several years, investors can see how meaningful Hercules' dividend can be to help bring some strength to your portfolio.
Right now could be a great time to take a look at Hercules stock while enjoying its juicy dividend yield of 9.1%.
HTGC Total Return Price data by YCharts
2. Ares Capital: 9.2% dividend yield
The second BDC on my list is Ares Capital(NASDAQ: ARCC). Ares is quite different than Hercules in that it generally works with lower-middle-market businesses that often go overlooked by private equity firms or investment banks.
Image source: Getty Images.
While this approach could be seen as risky, I think it opens Ares up to a number of opportunities that would otherwise be forgotten.
Similar to Hercules, Ares works with software and healthcare services companies as well. Although roughly one-third of its portfolio is allocated opportunities in software and healthcare, Ares also touches on industries such as media and entertainment, consumer goods, insurance, and real estate.
Image Source: Investor Relations
Dividend investors should pay particularly close attention to the figures in the slide above. The stats show that upwards of 40% of Ares' loans are first lien senior secured.
This means that Ares' loans sit above other debt that may be part of its clients' capital structure and they are backed by collateral. This is important because should an economic slowdown occur and its clients have trouble repaying their loans, Ares has the right to collect what it can one way or the other.
For this reason, I think that investors have little to worry about when it comes to the sustainability of the dividend.
ARCC Price to Book Value data by YCharts
Right now, Ares stock trades at a modest price-to-book (P/B) multiple of just 1.1 -- nearly identical to its 10-year average. I think now is a great opportunity for passive income investors to scoop up shares in Ares at a 9.2% yield and prepare to hold for the long run.
Should you invest $1,000 in Hercules Capital right now?
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Adam Spatacco has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Fastly and Pinterest. The Motley Fool recommends Rocket Lab USA. The Motley Fool has a disclosure policy.
