One of the secrets to Warren Buffett's success through the years has been to surround himself with smart people. Some of the stocks that have been big winners for him have stemmed from the ideas of others.
That's the case with the stock Buffett owns that currently offers the highest dividend yield. It's not a stock that the Oracle of Omaha himself selected. But it's making Buffett plenty of money. Here's why Buffett's highest-yielding dividend stock looks like a brilliant pick right now -- at least for some investors.
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Beyond Berkshire's portfolio
If we limited our sights to only the stocks listed in Berkshire Hathaway's (BRK.A -0.30%) (BRK.B -0.26%) 13-F filings, Paramount Global would rank as Buffett's highest-yielding stock. However, there actually are other stocks owned by Buffett that offer even higher dividend yields than Paramount.
Berkshire operates a subsidiary called New England Asset Management (NEAM). In 1995, NEAM was acquired by General Reinsurance. Three years later, Berkshire Hathaway acquired General Re. Since then, any stock in NEAM's portfolio has been, by default, a Buffett stock.
NEAM owns quite a few high-yielding dividend stocks. But one towers above all the others -- Ares Capital (ARCC -0.77%). Ares has paid dividends for more than 13 years with no dividend cuts.
The company's dividend yield currently stands at nearly 9.9%. Why does Ares have such a high yield? For one thing, Areas is a business development company (BDC). BDCs provide financing to small to medium-sized businesses. They're similar to real estate investment trusts in that they must return at least 90% of their taxable income to shareholders in the form of dividends to avoid federal taxes. More importantly, though, Ares has generated enough cash flow to pay out solid dividends.
Ares' advantages
Ares Capital is the largest publicly traded BDC. It has more than $350 billion in assets under management. The company's long track record and scale of operations give it a competitive advantage in attracting customers.
The market for direct lending to the middle-market companies Ares targets is growing. Also, larger companies are increasingly turning to direct lenders such as Ares to raise capital.
For investors, a key plus for Ares Capital is that its portfolio is much more diversified than most BDCs. Ares' strategy is to minimize the risk from any single business or industry. The company also remains highly profitable. Ares reported earnings of $174 million in its latest quarter and topped consensus analyst earnings estimates.
Ares Capital CEO Kipp deVeer said in the company's fourth-quarter update, "We are seeing a meaningfully more attractive risk-reward market environment." DeVeer thinks Ares is in a strong position to continue paying attractive dividends and delivering solid total returns.
Generating great total returns hasn't been a problem for Ares Capital in the past. From its initial public offering in 2004 through the end of 2022, the stock's cumulative total returns were roughly 90% higher than the S&P 500.
A brilliant pick -- with a few caveats
Ares Capital's juicy dividend and proven ability to manage risk make the stock a brilliant pick for many investors, in my opinion. However, Ares might not be attractive to every investor.
The prospects of an economic downturn could lead to more defaults by borrowers. DeVeer stated at the Bank of America Securities Financial Services Conference earlier this month that "things will get a little bumpier." He also said, though, that Ares Capital wasn't concerned about its ability to handle any potential headwinds.
Especially risk-averse investors might prefer to stay away from Ares Capital. But I think investors with long-term horizons -- especially those looking for income -- should take a hard look at Buffett's highest-yielding dividend stock.
