The higher the dividend yield, the higher the level of risk. That assumption has been the conventional wisdom of investors for a long time. It's usually correct -- but not always.
In some cases, stocks offer high yields without commensurately higher risk. I think that Ares Capital (ARCC 0.20%) stands out as a great example. Here's why buying $1,000 of this 10.6%-yielding dividend stock could be a brilliant move.
1. Its dividend appears to be sustainable
The main reason to even consider buying shares of Ares Capital is its dividend. However, some income investors might worry about whether the company can continue paying the dividend at current levels. My response to that concern is that Ares' dividend appears to be quite sustainable.
Ares Capital is the largest publicly traded business development company (BDC). It's registered as a regulated investment company, which means the company must return at least 90% of income to shareholders as dividends to be exempt from federal taxes.
All you have to do is look at Ares Capital's first-quarter results to gauge its ability to keep paying dividends at current levels. The company generated core earnings per share of $0.57, up more than 35% year over year. It used only $0.48 per share to fund the dividend.
Ares Capital focuses on investing in and lending to the upper middle market. It has little exposure to most sectors that are highly sensitive to inflation. The BDC's borrowers are financially healthy overall with weighted-average earnings before interest, taxes, depreciation, and amortization (EBITDA) growth of 8% year over year in Q1.
The company's balance sheet also doesn't present a problem with keeping the dividends flowing. Ares Capital has well-laddered debt maturities, with a net debt-to-equity ratio below 1.1x.
2. Its business prospects are strong
On a related note, Ares Capital's business prospects are strong. This should give investors increased confidence in the company's dividend. It could also bode well for the stock's performance going forward.
Ares Capital CEO Kipp DeVeer talked about the banking crisis in the company's Q1 call. He said that the issues facing some banks have led the industry to restrict access to capital. As a result, DeVeer believes that Ares Capital's solutions are "even more valuable."
He's not just guessing on this, though. DeVeer said that 95% of new leveraged buyout financing in Q1 was made by private capital providers -- a higher percentage than normal. He also stated that Ares Capital saw a 14% quarter-over-quarter increase in the first quarter of the number of deals evaluated. DeVeer noted that "similar periods of disruption have historically led to increased market share, profitability, and NAV [net asset value] growth" for Ares Capital.
3. It has a great track record
The current strong position of Ares Capital isn't a temporary fluke. Investors can rest easy knowing that the BDC has a great track record.
Ares Capital has been in business for nearly 20 years. During that time, it delivered a total return that trounced the S&P 500. DeVeer correctly pointed out in the Q1 call that his company also has an "industry-leading track record for credit performance since inception."
Speaking of leading the industry, Ares Capital has delivered the highest based dividend growth over the last 10 years among all publicly traded BDCs with market caps of over $700 million. It has produced the greatest NAV per share growth and total returns of the group as well.
This great track record also helps the company forge strong relationships with its customers. As a case in point, over 80% of Ares Capital's transactions in Q1 were with existing borrowers.
An income investor's dream
Every stock comes with some risks, of course. For example, Ares Capital's portfolio could face more stress if the U.S. economy enters into a recession.
Overall, though, this stock is an income investor's dream, with its juicy dividend, strong business prospects, and great track record. Ares Capital could even be the best ultra-high-yield dividend stock on the market right now.
