It’s been a great couple of years for investors holding U.S. equities. From the end of 2022 through Dec. 27, the benchmark S&P 500 index soared 55.5%.
While stock returns have been terrific, new investors seeking passive income learned the hard way that dividend yields fall when stock prices rise. The average stock in the benchmark index offers an unappealing 1.3% yield at recent prices.
Dividend yields among most S&P 500 stocks aren’t appealing, but there are a few business development companies (BDCs) that deserve more attention from income-seeking investors than they’ve been getting. Shares of Ares Capital(NASDAQ: ARCC), PennantPark Floating Rate Capital(NYSE: PFLT), and Hercules Capital(NYSE: HTGC) offer an average yield of 9.9% at recent prices. That means an initial investment of about $5,040 spread among them is enough to secure $500 in annual dividend payments.
Ares Capital is the largest BDC with shares that trade on public markets. The payout hasn’t risen in a straight line, but it’s risen by 20% over the past five years. It offers an 8.7% yield and the confidence that comes with a reliable track record.
The underwriters on Ares Capital’s investment committee have lent out $156 billion over the past 20 years. The average member has over 30 years of experience, and it shows in the company’s financial statements.
Ares Capital finished September with a loan portfolio worth $25.9 billion. Among the 535 companies in the portfolio, just a few are having a hard time paying their bills. Loans on nonaccrual status declined to 1.3% of the total portfolio at cost.
Around 69% of Ares Capital’s portfolio consists of loans that collect interest at variable rates. Rapid interest rate rises in 2022 led to more unpaid loans than usual. Fortunately, loans on nonaccrual status peaked during the first quarter of 2024 at just 1.7% of the portfolio at cost.
Ares Capital’s portfolio is already on steady ground. Now that the Federal Reserve has lowered its target rate by a full percentage point, it could get even steadier.
PennantPark Floating Rate Capital is another reliable BDC that could deliver heaps of passive income to your dividend portfolio. At recent prices, the stock offers a huge 11.3% yield and convenient monthly payments.
As its name implies, nearly all the loans this BDC writes collect interest at a lower rate now than they did a year ago. A lower-interest-rate environment isn’t ideal from a lender’s perspective, but it isn’t anything PennantPark Floating Rate Capital can’t handle. It’s been able to raise or maintain its dividend payout every year since it started paying one in 2011.
This BDC is focused on smaller middle-market businesses that earn between $10 million and $50 million annually before interest, taxes, depreciation, and amortization.
PennantPark’s portfolio is smaller than Ares Capital’s, but its underwriting team is arguably better at selecting borrowers capable of repaying their debts. Just two borrowers representing 0.4% of the portfolio at cost were on nonaccrual status at the end of September.
Hercules is another BDC with a mouthwatering dividend. At recent prices, it offers a 9.7% yield.
While PennantPark and Ares focus on run-of-the-mill businesses, Hercules Capital takes a different approach. Its $3.6 billion portfolio includes many small investments in innovative technology and life science companies.
At the end of September, it held equity positions in 76 companies and warrant positions in 98 companies. Many of these bets will fail, but the ones that succeed more than make up the difference. For example, the BDC’s equity investment in 23andMe hasn’t worked out, but a bet it placed on Palantir has grown more than tenfold.
As a BDC, Hercules must distribute at least 90% of earnings to shareholders as dividends. To account for the unpredictable nature of its equity and warrant portfolio, the BDC distributes a steady quarterly distribution, plus a supplemental distribution that varies.
Hercules Capital’s dividend is a lot more reliable than it looks on a chart. The standard quarterly payout it offers has moved in one direction since 2010, from $0.20 to $0.40 per share.
Investors could see a quarterly dividend raise, another big supplemental dividend, or a little of both in 2025. During the first nine months of 2024, total investment income rose 10% year over year.
In the first nine months of 2024, Hercules grew its debt portfolio by about 12%. That rapidly growing portfolio could produce rapidly growing profit that the BDC can distribute to your account every three months like clockwork. Adding some shares to a diverse portfolio looks like a great way to boost your passive income stream.
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Cory Renauer has positions in Ares Capital. The Motley Fool has positions in and recommends Palantir Technologies. The Motley Fool has a disclosure policy.
