Here's Why I Keep Buying This 10%-Yielding Dividend Stock

I'm not going to lie, I'm pretty addicted to collecting passive dividend income. While I love working, nothing beats getting paid for work someone else did. With a yield of more than 10%, few passive-income investments pay as well as Ares Capital (NASDAQ: ARCC) -- it's almost 10 times higher than the S&P 500's current yield of 1.1%.

That monster yield is why I just bought even more shares of this business development company (BDC).

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An ultra-high yield without the ultra-high risk profile

A dividend yield of 10% or more is usually a major red flag. However, that's not the case with Ares Capital. For starters, it's a BDC, which must distribute at least 90% of its taxable net income to shareholders in dividends to remain in compliance with IRS regulations. Given that payout requirement, it's going to have a high yield.

Further, where Ares Capital shines is in its ability to sustain and grow its dividend. It has maintained or raised its payout for 17 consecutive years. That's impressive for a BDC, as most of its peers have had at least one dividend reduction during that time frame. This durability is a testament to the company's strong underwriting, as its cumulative investments of more than $73 billion have a net realized loss of less than 0% since inception. That's a far better loss ratio than other BDCs (-1.1%) and even banks (-0.6%). By minimizing losses, Ares Capital has a long history of generating earnings that more than covered its dividend.

The red flag that's not as red as it seems

While Ares has historically covered its dividend with core earnings, it has slipped a bit this year. It delivered core earnings of $0.47 per share in both the first and second quarters, down from $0.50 per share over the previous three quarters and just below its $0.48-per-share quarterly dividend. That would seem to be a red flag at first glance.

However, core earnings don't include net realized gains or losses. While the BDC realized a net loss of $0.01 per share in the second quarter, it realized a net gain of $0.15 per share in the first quarter. Add the net $0.14 per share in realized gains to its core earnings, and the combined total easily exceeded this year's dividend payments. That adds to the cumulative cushion the BDC has built up. It entered this year with $1.38 per share of taxable income carried forward from last year, to be distributed to investors in 2026.

Why I keep buying Ares Capital

I previously started with a small position in Ares Capital that I'm expanding. One factor driving my recent addition is the decline in its share price (more than 5% this year), which has boosted its yield above 10%. I'm also growing more comfortable with the sustainability of its dividend, which has proven to be very durable over the years. I plan to add again if the share price keeps falling, with my next trigger point being a yield above 10.5%.

Matt DiLallo has positions in Ares Capital. The Motley Fool has positions in and recommends Ares Capital. The Motley Fool has a disclosure policy.