Warren Buffett likes dividends. His Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) portfolio is loaded with dividend stocks. The legendary investor talked about dividends quite a bit in his latest letter to Berkshire shareholders.
Buffett doesn't own all that many stocks that pay jaw-dropping yields. However, you might be surprised what you'll find if you look hard enough. Here's one Buffett stock with an ultra-high dividend yield of 10% -- and why it's a screaming buy right now.
A Buffett stock with a twist
No matter how hard you look, you won't find Ares Capital (ARCC 0.73%) listed among the holdings of Berkshire Hathaway. But Berkshire -- and by extension, Buffett --- does own the stock.
Ares Capital is included in New England Asset Management's portfolio. General Re acquired New England Asset Management (NEAM) in 1995. Three years later, Berkshire Hathaway acquired General Re. Ever since any stock that NEAM bought for its insurance industry clients became a de facto Buffett stock.
Buffett has been a big fan of bank stocks through the years in large part because banks provide much-needed services and can generate strong returns on equity. Ares Capital isn't a bank; it's a business development company (BDC). However, it checks off both of those boxes that Buffett likes about banks.
BDCs meet a need that many banks ignore: They provide financing to middle-market businesses (which typically have revenue between $10 million and $1 billion). As the largest publicly traded BDC, Ares Capital ranks as one of the biggest direct lenders to middle-market businesses.
Why Ares Capital stock is a screaming buy
Ares Capital stock isn't a screaming buy just because Buffett owns it via a Berkshire Hathaway subsidiary. It's a screaming buy for several other compelling reasons.
We have to start with that ultra-high dividend yield of a little over 10%. Importantly, Ares Capital can easily afford to continue paying the dividend at current levels. It also has a great track record of more than 13 years of stable to increasing dividends.
The company's business model makes such reliable dividend payouts possible. Ares Capital manages a $21.5 billion portfolio that's diversified across 475 companies that operate in 33 industries. It focuses on the upper end of the middle market and less cyclical industries, which means that its borrowers tend to be more stable.
Ares Capital's past performance speaks volumes about how well the company is managed. Its loss rates are much lower than BDC industry averages. Most impressively, the stock has delivered a total return that has trounced the S&P 500 over the last three years and since Ares Capital's IPO in 2004.
ARCC Total Return Level data by YCharts
The BDC stock is also attractively valued. Its shares currently trade at eight times forward earnings and a price-to-book ratio of only 0.84.
What could tarnish Ares Capital's luster?
Ares Capital's greatest risk is that the economy tanks. The stock fell much harder during the financial crisis of 2007 through 2009 and the COVID-19 meltdown of 2020 than the S&P 500 did.
If interest rates increase, it could negatively impact the number of deal opportunities for Ares Capital. The company also has more than $3.4 billion in debt maturing in 2026. If it has to refinance at significantly higher rates, the higher interest expense could affect the BDC's bottom line.
However, Ares Capital has successfully navigated macroeconomic challenges in the past. And the current situation doesn't appear to look all that bad. CEO Kipp DeVeer stated in the company's second-quarter conference call that "the economy is actually performing materially better than I might have expected."
It's certainly possible that things could take a turn for the worse and drag Ares Capital down in the process. For now, though, this is a stock with a mouthwatering dividend, a well-run underlying business, a fantastic track record of beating the market, and an attractive valuation. That's enough to make this Buffett stock a screaming buy, in my opinion.
