A Dividend Stock With a Double-Digit Yield: Is It Actually Sustainable?
Key Points
A double-digit dividend yield often isn't sustainable.
Ares Capital has paid a stable-to-growing dividend for more than 16 consecutive years.
The BDC's earnings exceed its dividend, and it has a strong financial profile.
The S&P 500's dividend yield is right around 1.2% these days, which is near its record low. As a result, most dividend stocks currently offer yields in the low single digits.
However, there are some outliers. One of those is Ares Capital Corporation (NASDAQ: ARCC). The business development company (BDC) currently yields 10.8%. While double-digit dividend yields aren't often sustainable, here's why Ares is different.
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BDCs aren't your average dividend stocks
Congress created BDCs in 1980 through an amendment of the Investment Company Act of 1940 to stimulate investment in smaller private companies. They make debt and equity investments, providing the capital smaller companies need to fund operations and expand. BDCs must meet several requirements, including paying out at least 90% of their taxable income in dividends. As a result, these entities tend to have higher dividend yields.
BDCs also have higher risk profiles. Private loans to small companies have default rates much higher than those of investment-grade bonds. However, they tend to carry higher interest rates. Those higher rates pose a risk, too, as borrowers often refinance this debt when rates fall, forcing the BDC to reinvest the repaid principal at lower rates. As a result, many BDCs have had to cut their dividends over the years.
Ares Capital isn't your average BDC
Ares Capital stands out in the BDC sector. It's the largest publicly traded BDC with a roughly $29.4 billion investment portfolio. It's part of the Ares Management franchise, a global leader in alternative investments. Ares Management has over $623 billion in assets under management, including nearly $407 billion of credit assets.
Ares Capital has leveraged its parent's credit expertise to deliver stellar results over the years. Its annualized net realized loan losses have averaged less than 0% since its inception, better than banks (-0.6%) and other BDCs (-1.1%). That has enabled Ares to pay one of the most bankable dividends in the sector. It has delivered stable to growing dividends for over 16 years.
While past success is no guarantee that Ares' dividend will remain sustainable, it's in a strong position to continue delivering stable dividends. The BDC produced $2.01 per share of core earnings last year, well in excess of its dividend ($1.92 per share). The company estimates that it will carry forward about $1.38 per share of excess taxable income from last year to distribute to shareholders in 2026, providing additional cushion for the dividend. Ares also has a strong financial profile, enabling it to continue growing its investment portfolio.
Ares's double-digit dividend looks sustainable
Ares Capital has paid a stable or growing dividend for over a decade-and-a-half. Its current payout appears sustainable, supported by excess earnings and a strong financial profile. While things could change if the economy deteriorates significantly and impacts its portfolio companies' ability to repay their loans, Ares Capital looks like a sustainable source of dividend income.
Should you buy stock in Ares Capital right now?
Before you buy stock in Ares Capital, consider this:
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Matt DiLallo has positions in Ares Capital. The Motley Fool has positions in and recommends Ares Capital. The Motley Fool has a disclosure policy.
