There's a pretty good chance you've never heard of Ares Capital(NASDAQ: ARCC). It's not the kind of stock that attracts a lot of attention. With a market cap of under $12 billion, Ares Capital is still small enough that it can fly under the radar screens of many investors.
However, I think that Ares Capital deserves a hard look, especially for income investors. Here are seven reasons buying this dividend stock could be a brilliant move.
1. An ultra-high dividend yield
I'll start with the obvious big plus for buying shares of Ares Capital -- its ultra-high dividend yield. The headline of this article referred to Ares as a "9.5%-yielding dividend stock." That's correct if we round down: Ares Capital's dividend yield currently stands at 9.58%.
2. A good dividend track record
A mouth-watering dividend yield wouldn't mean much if the dividend was likely to be slashed in the near future. That shouldn't be a worry with Ares Capital. The company has a good dividend track record with 14 years of stable to growing dividends.
3. Solid earnings growth
Ares Capital also appears to be in great shape to keep that impressive dividend track record going. The company earnings per share based on generally accepted accounting principles (GAAP) more than doubled year over year in the fourth quarter of 2023. Over the last five years, Ares Capital's net income on a trailing 12-month basis has grown by roughly 83%.
4. A compelling business model
Ares Capital's dividends and earnings growth are the end results of what I view as an exceptionally compelling business model. Ares ranks as the largest publicly traded business development company (BDC). Many banks have shied away from middle-market direct lending. That's opened the door for BDCs such as Ares Capital to step in. Larger companies have also increasingly turned to direct lending for raising capital in part because of the speed in closing financing deals.
5. An excellent risk management strategy
Direct lending to middle-market companies can be risky at times. However, Ares Capital's risk management strategy gives it more stability than most of its peers. The BDC focuses on the upper end of the middle market. It avoids highly cyclical industries. Ares Capital's portfolio is much more diversified than the average BDC. The company does a lot of repeat business with existing customers that it knows well. It's also highly selective, closing only around 5% of the transactions that it considers.
6. A history of beating the market
Ares Capital has outperformed every other BDC with a market cap of $700 million or more over the last 10 years in net asset value (NAV) per share growth, annualized total return, and base dividend per share growth. More importantly, Ares has generated cumulative total returns that are more than 75% higher than the S&P 500 since its IPO in 2004. Over the last three years, the BDC's total return has handily beaten the S&P's.
ARCC Total Return Level data by YCharts
7. An attractive valuation
With all of the positives already discussed, you might think that Ares Capital would trade at a premium. That's not the case. Instead, the stock's valuation is quite attractive with shares trading at a little over 8.3 times forward earnings. That's dirt cheap compared to the S&P 500's forward earnings multiple of 20.7x.
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Keith Speights has positions in Ares Capital. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
