Pick a category. You’ll find some members of that category that especially stand above the rest of the pack.
In the category of dividend stocks, I think Ares Capital (ARCC 0.30%) serves as a great example. The business development company (BDC) offers a dividend yield of more than 9.6%. This ultra-high-yield dividend stock looks like a no-brainer buy right now for income investors.
Firing on (nearly) all cylinders
Ares Capital reported its fourth-quarter and full-year results on Thursday. It’s fair to say the company is firing on nearly all cylinders.
It delivered record core earnings per share last year, and fourth-quarter core earnings per share tied an all-time high. Earnings based on generally accepted accounting principles (GAAP) more than doubled year over year. The BDC’s net asset value per share also reached a record level in Q4.
Just how good is business for Ares Capital these days? CEO Kipp deVeer noted on the quarterly conference call that in Q4, the company “saw more transactions than were reported in the broadly syndicated loan and middle market combined.” Co-President Kort Schnabel added more detail, revealing that Ares Capital’s new commitments in Q4 jumped nearly 50% from the previous quarter while the reported numbers for the broadly syndicated and middle market fell quarter over quarter.
The only thing for Ares Capital that is not performing as well is its stock. The BDC’s share price is down slightly over the last 12 months while the S&P 500 has soared by close to 20%. DeVeer expressed surprise that Ares Capital stock hasn’t performed better, especially considering its increase in book value last year. It’s important to note, though, that the BDC’s total return is much higher than its share appreciation thanks to the juicy dividend.
Bright prospects ahead
The future looks bright for Ares Capital as well. The company expects greater deal activity in 2024 than it saw last year. DeVeer said that activity volumes so far in the first quarter are “definitely better than they were at this time last year.”
Importantly, the financial health of the middle-market companies in Ares Capital’s portfolio appears to be solid. Schnabel noted that the weighted-average EBITDA of the BDC’s portfolio companies jumped 9% year over year in Q4.
DeVeer confirmed that the trend of large, high-quality companies turning to Ares Capital for financing seen in 2023 is continuing so far this year. He said that it wasn’t because these companies couldn’t tap public markets; they’re instead going with Ares Capital, in his view, “because they prefer the stability that we provide through market cycles.”
Ares Capital has plenty of cash to fund new investments. The company has raised $1.3 billion since the beginning of the fourth quarter by issuing unsecured notes with favorable terms. After that capital raise, Ares Capital has more than $6 billion that it can put to work. As of Feb. 1, the BDC’s backlog and pipeline totaled over $1.1 billion.
A no-brainer buy
Any stock that offers a dividend yield as high as Ares Capital’s is bound to catch the eyes of income investors. The company’s track record of paying stable-to-increasing quarterly dividends over the last 14 years is another plus.
There’s also valuation to consider. Ares Capital’s shares currently trade at a little over 8.7 times forward earnings and a price-to-book ratio of only 1.05.
Granted, the BDC faces some risk that its portfolio companies could default on their loans. As previously noted, though, the average EBITDA for these companies continues to rise. Also, 89% of the companies and 93% of the portfolio’s fair value are in Ares Capital’s two lowest-risk grades.
What about Ares Capital’s subpar stock performance over the last 12 months? That’s an anomaly. Over the long run, the stock’s total returns have handily beaten the S&P 500.
The bottom line is that Ares Capital offers an ultra-high yield, a solid dividend track record, good business prospects, an attractive valuation, and a great long-term history of beating the market. I think all that adds up to make this stock a no-brainer buy for income investors.