Ares Capital Outperforms Market, Drawing Attention Despite Unusual Yield

Ares Capital, a business development company (BDC) offering a substantial 9.9% yield, has caught the attention of the investment world for its impressive performance over the past three years. Even though it diverges from the typical low-yield dividend stocks favored by Warren Buffett, it is a part of the portfolio of New England Asset Management (NEAM), a subsidiary of Berkshire Hathaway (NYSE:).

Berkshire Hathaway, led by Buffett and his longtime business partner Charlie Munger, acquired NEAM as part of its acquisition of General Re in 1998. While Ares Capital was not directly selected by Buffett or Munger, its presence in the NEAM portfolio indirectly ties it to the renowned investor’s empire.

Ares Capital distinguishes itself as the largest publicly traded BDC and specializes in financing middle-market businesses, a sector often bypassed by banks. Akin to real estate investment trusts (REITs), BDCs are mandated to return at least 90% of their taxable income to shareholders as dividends. This policy can lead to dividend cuts during times of substantial earnings fluctuations. However, Ares Capital has managed to sidestep this issue for over 13 years by consistently generating substantial profits.

The company’s risk management strategy within direct lending is another strength. Ares Capital steers clear of more cyclical and volatile industries and maintains a diverse portfolio with 475 companies, none of which represent more than 2% of the total. Its focus is on the upper end of the middle market, which tends to be less risky.

Since its IPO in 2004, Ares Capital’s average annual total return has exceeded 12%, surpassing both the BDC industry average and the ‘s average total return during that period. In fact, over the last three years, Ares Capital’s total return has essentially doubled that of the S&P 500.

Despite its notable performance, Ares Capital carries inherent risks. The company holds around $11.4 billion in debt, a common characteristic of BDCs. This debt could become problematic if Ares Capital’s borrowers default, especially in an economic downturn.

Nonetheless, Ares Capital’s forward earnings multiple of just 8.7x is seen as a bargain in today’s high-valuation stock market, making it an attractive opportunity for income investors. While not directly picked by Buffett himself, Ares Capital arguably ranks as his top ultra-high-yield dividend stock.

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