Best Stocks for 2020: Hercules Capital Stock Is an Investment in Alchemy

© Source: Chart by TradingView Bright blue logo that reads “10 Best Stocks for 2020 by InvestorPlace.”

Editor’s note: This column is part of InvestorPlace.com’s Best Stocks for 2020 contest. Neil George’s pick for the contest is Hercules Capital (NYSE:HTGC).

© Provided by InvestorPlace Bright blue logo that reads “10 Best Stocks for 2020 by InvestorPlace.”

Hercules Capital (NYSE:HTGC) has been my recommendation as part of the InvestorPlace Best Stocks for 2020 contest. And for the third quarter, the stock has returned 13.55% which has outpaced the S&P 500 by an ample margin amounting to 4.62%.

And HTGC stock did this with the addition of its dividend yield of 11.7% on an annual basis. The dividends come both in regular distributions as well as ongoing additional distributions from transactional profits of the company.

And the distributions are up by 6.11% for the trailing year — continuing the trend of increases over the past five years.

© Provided by InvestorPlace A chart showing the total return of Hercules Capital (HTGC) over the third quarter.

Hercules Capital (HTGC) Total Return Third Quarter 

Load Error

Hercules is one of a great collection of companies that is set up under the Investment Companies Act of 1940 as well as the Small Business Investment Incentives Act of 1980. Under these laws, the company can make specific investments in its operations while avoiding federal income taxes. Why does this matter? Well, Hercules can now pay out more cash to shareholders.

HTGC is structured as a business development company, or BDC. This format allows it to provide loans and financing to other companies, much like commercial banks. But there is a key difference. Hercules is shielded from the litany of regulatory woes which continues to plague banks after the 2007-2008 financial mess.

Importantly, these laws also allow the company to take other financial and equity investments in its operations. As a result, Hercules not only earns interest, but gains over time through the successes of its clients.

Hercules Benefits From BDC Structure

This corporate structure also means that Hercules can operate without the onerous capital and compliance costs which have crippled many of the commercial banks in the U.S. This means lower costs and better operating margins. And it shows up in a much better efficiency ratio, which measures how much it costs to generate each dollar of revenue.

There is another big difference between Hercules and commercial banks. HTGC doesn’t need to rely on deposits, which given the current yield environment, are still costly when compared to lending rates for short- to intermediate-term loans. This means better net interest margins (NIM).

And then we get to the elections. There has been a lot of rhetoric over re-regulating or further restricting U.S. banks by some on the campaign trail. While major banks and financials do have a lot to fear, none of this is focused on Hercules and its peers in the BDC segment.

This makes the company an under-the-radar opportunity which has been faring well and should continue to fare well into 2021 — regardless of electoral results.

And it is not just about the structure of the company. It also has a unique focus and successful history in capitalizing on one of the U.S. economy’s best growth segments — technology.

Alchemy Investing: Why HTGC Is One of the Best Stocks

I continue to look at technology and technology investing as like alchemy. Some are taking grains of silicon, transforming them into must-have electronic gizmos and gadgets. Others take from thin air the most innovative of ideas, propelling new services that disrupt industries. Regardless, technology is all about making something seemingly worthless into riches.

And the epicenter for much of the technology of the U.S. — as well as the globe — can be found in Silicon Valley in the pleasant town of Palo Alto, California.

This is where so many modern technologies have been conceived, developed and brought to eager markets. And those behind the whiz-bang products and services often become billionaires in the process.

Despite the wealth of success stories, it is not an easy path. For just as there have been many tech titans that built impressive companies, there are many more that never make it out of the garage.

This is where financial backing and guidance come in. Ideas are only as good as they can be brought to the market. Companies are only as good as their management and their labs.

HTGC Stock Has a Magical Portfolio

This is why Hercules is based in the heart of Palo Alto, as an investment company that focuses on financing and guiding technology companies from start to IPO, or alternate exit strategies. It gets to know everyone at every stage of technology development in town.

The company has more than 350 current investments in varied groups of technologies. They include internet consumer and businesses, clean and green technology businesses and drug development companies.

Hercules has a long track record of participating in many successful companies. It has guided Box (NYSE:BOX), Pinterest (NYSE:PINS), FanDuel, Sling Media, Ancestry.com and BrightSource Energy.

The company scouts out innovators in various stages of developments. And in turn, Hercules creates financing to fund their development. But beyond just making loans, it also takes equity stakes in the companies either directly or via warrants that provide it the ability to cash in when companies complete their IPOs or other exit strategies.

It has been in the business since 2004. Since coming to the public market in June 2005, it has generated a return for investors of 312.63%, which equates to an average annual equivalent of 9.68% per year.

© Provided by InvestorPlace A chart showing the total return of Hercules Capital (HTGC) stock since its IPO. Source: Chart by Bloomberg

Hercules Capital (HTGC) Total Return Since IPO

Hercules By the Numbers

The company continues to ramp up revenues, with the trailing year showing gains of 28.9%. Revenues have been gaining since the IPO running at an average of 34.31% on a compound annual growth rate (CAGR) basis.

© Provided by InvestorPlace A chart showing the historical revenue of Hercules Capital (HTGC). Source: Chart by Bloomberg

Hercules Revenue

Its NIM is more than ample at 8.9%, which means that its cost of funds is significantly below its loan revenues. This is a dream of most banks and financials that are trying to compete with the company.

And unencumbered by regulatory woes, its efficiency ratio is running at 15.8%, meaning that it only costs 15.8 cents for each dollar of revenue — again an envy of many traditional lenders in the U.S.

This drives a return on its assets of 4.1%, which is multiples of traditional lending banks. And the return on equity is an also ample 8.5%, again great for a financial.

Leverage is not a threat, as its debts are a mere 52.7% of assets. This means that if the U.S. credit markets run into additional issues for 2021, the company is in good credit condition.

And as noted above, the company is very focused on shareholders with its dividend distribution.

© Provided by InvestorPlace A chart showing the historical dividend distributions of Hercules Capital (HTGC). Source: Chart by Bloomberg

Hercules Dividend Distribution History

Best Stocks: HTGC Stock Represents Pure Gold

Now, you might expect to pay up for the stock of such a good company in a good market and segment. But it is only valued at 1.16 times the intrinsic value of its impressive book of net assets. And that book value continues to advance. This means that investors aren’t just getting a rising stock price, but rising underlying assets as well.

© Provided by InvestorPlace A chart showing the historical book value per share of Hercules Capital (HTGC). Source: Chart by Bloomberg

Hercules Book Value per Share

All of this comes down to a well-run technology investment company with tax advantages, big dividends and positive underlying financial conditions and performance. This year and beyond should be rewarding for this alchemy-investment in Hercules Capital.

On the date of publication, Neil George did not hold (either directly or indirectly) any positions in the securities mentioned in this article.

As the editor of Profitable Investing, Neil George helps long-term investors achieve their growth & income goals with less risk. With 30-plus years of experience in the financial markets, Neil recommends undiscovered and underappreciated companies that offer subscribers double-digit yields now and triple-digit returns over time.

Continue Reading