Van Halen had a hit single during the band's Sammy Hagar years, called "Best of Both Worlds." The song had nothing to do with investing (shocking, right?). However, I do think many investors would like the sentiment of the catchy tune. They'd love to have the best of both worlds, with stocks that provide high yields and deliver strong growth.
There's one famous investor who actually has enjoyed that kind of best-of-both-worlds scenario. Warren Buffett doesn't own many dividend stocks with especially high yields and even fewer that have also beaten the market. But he does have one ultra-high-yield dividend stock that has absolutely trounced the S&P 500 in recent years.
Image source: The Motley Fool.
Buffett's hardest-rocking dividend stock
You'll find a lot of dividend stocks in Buffett's Berkshire Hathaway portfolio, though none offer ultra-high dividend yields. However, Buffett does have a handful of stocks in his "secret portfolio" that qualify.
What is Buffett's secret portfolio? One of Berkshire's subsidiaries is investment firm New England Asset Management (NEAM). Every stock in NEAM's portfolio is owned just as much by Buffett as the stocks listed in Berkshire's portfolio.
NEAM holds positions in several stocks with ultra-high dividend yields. For example, AT&T, Golub Capital, and Verizon Communications have yields of greater than 6%. But one dividend stock towers above them all as Buffett's highest-yielding dividend stock.
Ares Capital's (ARCC 0.39%) dividend yield currently stands at 10.6%. Its yield hasn't been below 5% since 2005, the year after the company's initial public offering. Ares Capital also hasn't cut its dividend payout in over 13 years.
How Ares Capital beat the market like a drum
Over the last one-year, three-year, and five-year periods, Ares Capital has delivered higher total returns than the S&P 500. But the stock appears even more impressive when you look at its performance since inception.
ARCC Total Return Level data by YCharts.
How has Ares Capital beaten the market like a drum? One key factor is the company's business model. Ares is a business development company (BDC) that lends to middle-market businesses. BDCs have enjoyed greater opportunities over the last few decades as many banks have stepped back from middle-market direct lending.
BDCs registered as regulated investment companies are similar to real estate investment trusts (REITs) in that they must distribute at least 90% of income to shareholders to avoid federal taxes. As a result, many BDCs offer juicy dividend yields. Ares Capital's dividend has been the primary driver of its outstanding total return through the years.
It's important to note that Ares Capital hasn't been so successful just because it's a BDC. Actually, BDCs as a group have generated a lower average total return than the S&P 500 since Ares Capital went public. Ares Capital has differentiated itself by diversifying its portfolio more than its peers and by focusing on the upper end of the middle market.
Is Buffett's ultra-high-yield dividend stock a buy right now?
Ares Capital CEO Kipp deVeer stated in the fourth-quarter conference call last month that the company is "seeing a meaningfully more attractive risk-reward market environment." However, he also acknowledged at the recent Bank of America Securities Financial Services Conference that defaults are likely to rise this year with higher interest rates.
Some risk-averse investors might prefer to stay away from Ares Capital, given the current economic uncertainty. However, the BDC has demonstrated that it knows how to manage risk effectively. I think the stock is a brilliant pick for long-term investors willing to take on some risk. As Van Halen sang in the David Lee Roth years, "Go ahead and jump."
