Should You Buy Ares Capital Stock While It's Below $25?

Key Points

• Ares Capital offers an exceptionally juicy dividend.

• It's a clear leader in a fast-growing market.

• The stock's valuation is also compelling.

• 10 stocks we like better than Ares Capital ›

You won't find many large-cap, ultrahigh-yield dividend stocks with relatively low share prices that are popular on Wall Street. However, Ares Capital (NASDAQ: ARCC) fits the bill.

Eleven of the 14 analysts surveyed by LSEG (OTC: LNST.Y) in July recommended Ares Capital as a "buy" or a "strong buy." Should you buy Ares Capital stock while it's below $25? Here are four reasons why I think the answer is a resounding "yes."

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1. A fantastic dividend

There was no way I wasn't going to begin the discussion of why to invest in Ares Capital without mentioning its fantastic dividend. The stock offers a juicy dividend yield of 8.36%. A sky-high yield is nothing new for Ares Capital. Over the last 10 years, its average yield was 9.32%.

Want even better news? Ares Capital has maintained a steady or growing dividend for over 15 consecutive years. It has increased the dividend payout by 20% over the past five years.

I don't expect this great dividend track record to end anytime soon. Ares Capital is a business development company (BDC), which means it must return at least 90% of its income to shareholders as dividends to avoid paying federal income taxes. As long as the company is profitable, it's going to pay dividends.

2. A growing market

BDCs provide capital primarily to middle-market businesses with annual revenue between $10 million and $1 billion. Their main vehicle is direct lending. And this market is growing rapidly.

According to State Street (NYSE: STT) Investment Management, the private credit market has nearly tripled over the last decade to around $2 trillion. Most of this growth is due to direct lending. Morgan Stanley (NYSE: MS) projects that the private credit market will grow to $2.8 trillion by 2028. McKinsey estimates that the total addressable market for private credit could top $30 trillion in the U.S. alone.

I believe Ares Capital is in the right business at the right time.

3. An industry leader

Ares Capital is also the industry leader in the right business at the right time. It's the largest publicly traded BDC in the U.S., with a market cap of close to $16 billion.

The stock has delivered an average annual total return of 13% since its initial public offering in 2004. That's roughly 80% higher than the S&P 500's (SNPINDEX: ^GSPC) total return during the period. Over the last 10 years, Ares Capital has ranked No. 1 in annualized stock-based total return among its peer group.

I attribute this success to Ares Capital's diversified, high-quality portfolio. The BDC currently has 566 companies in its $27.1 billion portfolio. The average position size is only 0.2%, with the largest investment making up around 2% of total assets. Roughly 68% of the portfolio consists of senior secured loans, which are secured by collateral and have the highest priority for repayment.

It's also reassuring that Ares Capital is supported by an industry-leading external manager, Ares Management (NYSE: ARES). At last year's Alternative Credit Awards, Ares Management was named the 2024 Alternative Fund Manager of the Year. Private Debt Investor magazine selected Ares Management as the 2024 Global Fund Manager of the Year.

4. A compelling valuation

Another reason to buy Ares Capital while it's below $25 is its compelling valuation. And I'm not talking about the share price itself.

Ares Capital's forward price-to-earnings ratio is only 11.3, according to LSEG. That's roughly half the forward earnings multiple of the S&P 500. Granted, BDCs tend to trade at lower valuations. But keep in mind that Ares Capital has trounced the S&P 500 over the long term. With its ultrahigh dividend yield, combined with a leading position in a fast-growing industry, I think the price is right for this outstanding BDC stock.

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Keith Speights has positions in Ares Capital. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.