Here are my top 5 ultra-high yield dividend stocks to buy by hand

One of the cornerstones of a diversified portfolio should be dividend stocks.

Dividend stocks are important because the passive income they generate can mitigate some of the losses you may experience due to stock price volatility. Plus, replenishing your portfolio with a steady stream of dividend income can come in handy when you need cash.

Let’s examine five stocks that are proven, reliable dividend payers and assess why now seems like a good time to pick up shares in each.

1. Hercules Capital: 9.9% dividend yield

One of the best sources of dividend income comes from business development companies (BDCs). BDCs are structured so that 90% of their taxable income is paid out to shareholders annually in the form of dividends.

Hercules capital (NYSE:HTGC) is a leading BDC specializing in high-interest loans to companies in the technology, life sciences and energy sectors. Because BDCs make loans, it is critical that the portfolio companies can repay principal and interest.

According to company filings, a debt investment is categorized as a non-accrual “when it is probable that principal, interest or fees will not be collected according to contractual terms.”

The table below illustrates non-accruals as a percentage of Hercules’ total portfolio:

Data source: Hercules Investor Relations

Considering that only about 1% of Hercules’ total portfolio is at risk, I’d say the company is fairly well managed.

Not only does Hercules offer a juicy 9.9% dividend yield, but the stock’s overall long-term performance is equally impressive. Over the past ten years, Hercules shares have achieved a total return of 278%.

The chart above illustrates that a $10,000 investment in Hercules ten years ago would be worth over $37,000 today. Not only does this underline the importance of reinvesting dividends, but it also makes a case for Hercules as a long-term prospect.

2. Horizon Technology: dividend yield of 11.4%

In general, startups will initially seek funding from private equity or venture capital firms in their early stages. However, during each round of funding, the startup’s employees and founders become diluted as the investment companies acquire shares in the company in exchange for capital.

This is what makes BDCs so attractive. Because debt does not lead to dilution, companies often forego raising equity as the business matures.

The story continues

Horizon Technology (NASDAQ: HRZN) is another technology and healthcare BDC. The company competes heavily with Hercules and offers a similar range of venture capital term loans used for acquisition capital or cash runway.

A unique feature of Horizon is that the deal terms are often accompanied by warrants. While Horizon makes its bread and butter from the interest on the repayment of its loans, warrants provide an additional incentive to profit if one of its portfolio companies is acquired or goes public.

Currently, Horizon Technology is trading at a price-to-book (P/B) multiple of 1.2. Competitor Hercules Capital, on the other hand, has a P/B of 1.6.

At just $11 per share, Horizon stock is trading in the middle of its 52-week range. Given the discount to the company’s closest rival and the blistering 11% yield, now seems like a tempting time to pick up shares.

3. Ares Capital: dividend yield of 8.9%

The last BDC on my list is Ares Capital (NASDAQ: ARCC). While BDCs such as Hercules and Horizon focus on fast-growing sectors, Ares takes a different approach.

The firm generally works with lower mid-market companies that are being passed over by large investment banks or consulting firms. The other feature that makes Ares unique is that it offers a deeper variety of financial instruments compared to most BDCs.

While BDCs typically specialize in term loans and revolving lines of credit, Ares has the financial strength to execute more sophisticated transactions, including leveraged acquisitions, recapitalizations and restructurings.

Like Hercules, Ares’ portfolio is consistently strong. As of March 31, the company’s non-accrual rate was just 1.7%. This is much lower than the average rate of 3.8% in the broader BDC landscape.

This achievement speaks volumes about the quality of Ares’ due diligence and the company’s ability to execute a wide range of financial products.

Over the past ten years, Ares has achieved a total return of 230%, which is handily at the top S&P500.

Given its differentiating features versus other leading BDCs, coupled with strong long-term performance and an ultra-high dividend yield of 9%, Ares stock may be worth putting on your radar.

4. Altria: dividend yield of 8.5%

There are many other ways to find dividend stocks outside of BDCs. A great place to start is the Dividend Kings list.

Dividend Kings are an extremely rare breed of companies that have both paid and increased their dividends for at least 50 consecutive years.

One of the longest-standing Dividend Kings is the tobacco company Altria (NYSE:MO). Altria owns a number of cigarette and tobacco brands, including Marlboro and Black & Mild.

I would understand if the graph above gives you some fear. The ebb and flow of Altria’s revenues and operating profits don’t exactly bode well for the company.

However, Altria is currently going through something of a renaissance. While sales of traditional tobacco products such as cigarettes are declining, the company has identified some emerging growth opportunities that are showing some encouraging progress.

Altria is investing heavily in ‘smokeless tobacco’ products such as vapes and nicotine pouches. These products unleash new sources of growth for Altria, allowing the company to penetrate retail markets and begin writing the first chapters of a turnaround story.

While it will take some time before Altria returns to accelerating sales and profits, I believe the company is making the necessary strategic moves to maintain a leading position among tobacco brands. More importantly, given that this isn’t the first time in Altria’s history that it’s needed to navigate shifts in consumer trends, I’m optimistic the company will maintain its dividend over the long term.

5. Western Midstream Partners: 9.3% dividend yield

Another good source of passive income can be found in master limited partnerships (MLPs). MLPs are intriguing businesses because they essentially act as pass-through entities for investors (limited partners).

Investors in MLPs can take advantage of certain tax benefits as any losses faced by the company are passed on to LPs. Additionally, MLPs pay a large portion of their income to investors every quarter. These payments are known as distributions and are essentially the same as a dividend.

I recently wrote a piece about it Western Midstream (NYSE: WES) and why I think billionaire investor Bill Gross could see the stock as a hedge against fixed income. Gross has made a name for himself in the bond sector, so it’s likely that when he invests in stocks, he’ll be looking for steady growth opportunities.

Another feature that makes MLPs attractive investments is that they tend to be better insulated from the commodity-based volatility in the broader energy sector because they enter into long-term, fixed-fee contracts with their customers.

The charts above illustrate Western Midstream’s price-to-earnings (P/E) ratio, as well as its return on free cash flow. The obvious theme here is that the Western mid-market generally has significantly higher free cash flow compared to industry-adjacent opportunities in the utilities, industrials and basic materials sectors. But despite these results, Western Midstream’s price-to-earnings ratio trades at a significant discount.

I think this dynamic makes Western Midstream particularly attractive because the company consistently generates cash flow, which it then uses to periodically increase distribution payments. However, the difference between Western Midstream’s valuation multiples and those of other cash-generating opportunities is difficult to ignore.

Considering the company offers a 9% dividend yield and is trading significantly lower than its cohorts, investors may want to pick up some shares.

Should you invest $1,000 in Hercules Capital now?

Consider the following before purchasing shares in Hercules Capital:

The Motley Fool stock advisor The analyst team has just identified what they think is the 10 best stocks for investors to buy now… and Hercules Capital wasn’t one of them. The ten stocks that survived the cut could deliver monster returns in the coming years.

Think about when Nvidia created this list on April 15, 2005… if you had $1,000 invested at the time of our recommendation, you would have $671,728!*

Stock Advisor provides investors with an easy-to-follow blueprint for success, including portfolio building guidance, regular analyst updates, and two new stock picks per month. The Stock Advisor is on duty more than quadrupled the return of the S&P 500 since 2002*.

View the 10 stocks »

*Stock Advisor returns May 28, 2024

Adam Spatacco has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Here are my top 5 ultra-high yield dividend stocks to buy Hand Over Fist was originally published by The Motley Fool