The stock market is poised for another up year. However, the good times aren't rolling for every stock. Ares Capital (ARCC 0.75%) is in negative territory year to date.
However, this leading business development company (BDC) has been a big winner for investors over the long run. Should you buy Ares Capital while its share price is below $21? Here are three reasons why you might want to consider doing so.
NASDAQ: ARCC
Key Data Points
1. Lock in an exceptionally high yield
One tremendous advantage of buying shares of Ares Capital now is that you can lock in an exceptionally high yield. The stock's forward dividend yield currently stands at 9.3%. That level is enough to make many income investors drool.
The obvious question, though, is: Could Ares Capital cut its dividend? I don't think there's any reason to worry about this possibility. The company continues to generate ample earnings to cover its dividend payments.
Importantly, Ares Capital has either maintained or grown its dividend for more than 16 consecutive years. Its management undoubtedly wants to do everything within its power to keep that streak going. When the dividend is such an important part of the overall investment thesis for a stock, as is the case with Ares Capital, there's plenty of motivation to avoid dividend cuts.
2. Buy at a discount
The stock market is priced for perfection. The S&P 500 (SNPINDEX: ^GSPC) Shiller CAPE ratio isn't far away from its highest level ever. The record high, by the way, was set in early 2000, shortly before the dot-com bubble burst. Legendary investor Warren Buffett has been a net seller of stocks for 11 consecutive quarters.
Ares Capital looks like a dirt cheap bargain in the midst of these dynamics. Its forward price-to-earnings (P/E) ratio is only 10.6.
Granted, publicly traded BDCs typically have relatively low earnings multiples. For example, Blue Owl Capital (OBDC 1.34%) trades at 8.6 times forward earnings. Golub Capital's (GBDC 1.14%) forward P/E ratio is 9.3. But Ares Capital's valuation is well below Main Street Capital's (MAIN 1.30%) forward earnings multiple of 16.
Also, Ares Capital's trailing 12-month P/E ratio is more than 20% below the average level over the last 10 years. I think that when all factors are considered, investors have an opportunity right now to buy this BDC stock at a discount.
Image source: Getty Images.
3. Begin profiting from Ares Capital's long-term opportunity
The demand for direct lending continues to grow. Borrowers like the streamlined process and increased certainty of closing that BDCs offer. When banks tighten the screws on capital availability during volatile periods, BDCs can provide the money businesses need.
If we only look at the traditional middle market businesses with annual revenue of $100 million to $1 billion, Ares Capital's total addressable market would be around $3 trillion. However, including the opportunities to provide financing to businesses with annual revenue of over $1 billion that might be interested in direct lending expands the total addressable market to $5.4 trillion.
Ares Capital is arguably in a better position than any of its peers to succeed in the huge market. It's the largest publicly traded BDC. The company has a strong balance sheet. It has a more diverse portfolio than most BDCs. And Ares Capital has solid, long-term relationships with customers and financial institutions.
Since its initial public offering in 2004, Ares Capital has generated a total return that has trounced the S&P 500's. Buying this stock while its share price is below $21 could enable investors to begin profiting from the new stage of this top BDC's long-term opportunity.
