Should You Buy Ultra-High-Yielding Ares Capital Corporation While It's Below $22.50?

If you're looking for an easy way to boost your passive income, consider investing in dividend stocks. One standout dividend stock is Ares Capital Corporation (NASDAQ: ARCC). With a dividend yield of 8.7%, Ares Capital pays a dividend over seven times that of the S&P 500 index.

Ares Capital plays a key role by providing loans to mid-sized businesses, which are overlooked by traditional banks. With a solid track record of navigating economic downturns, Ares has proven its ability to manage risks effectively.

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However, the stock has experienced some turbulence recently, amid market volatility stemming from economic uncertainty. If you're considering adding ultra-high-yielding Ares Capital to your portfolio, here's what you need to know first.

Ares Capital fills a hole left by the banking system

Ares Capital operates as a business development corporation (BDC), an attractive investment structure for those seeking high-yield income. When set up as a Regulated Investment Company, BDCs must distribute at least 90% of their taxable income to shareholders, allowing investors to benefit directly from the corporation's profitability.

Ares Capital specifically targets middle-market companies -- those with earnings before interest, taxes, depreciation, and amortization (EBITDA) ranging from $10 million to $250 million. These mid-sized companies often find themselves underserved by traditional banks, which may shy away from lending due to their smaller size and the perceived credit risks involved.

In recent decades, the number of banks has declined significantly due to consolidation. Coupled with stricter regulations following the Great Recession, banks have shifted their focus toward larger businesses, which they deem to carry less risk and offer more liquid debt. As a result, banks' share of the senior secured loan market has plummeted, creating a lending opportunity for BDCs like Ares Capital.

Another aspect that makes Ares Capital appealing for investors is its use of floating-rate loans, which adjust with changes in interest rates. As rates rise, so too can Ares' income, enabling the potential for increased dividend payments to investors.

Image source: Getty Images.

Keep an eye on credit quality amid economic uncertainty

Managing debt within middle-market companies presents unique challenges that investors should be aware of. Unlike larger corporations, these companies often have less flexibility and may be more susceptible to risks, especially during times of economic uncertainty characterized by inflation, rising tariffs, and supply chain disruptions.

One thing to watch is credit quality. Non-accrual loans are those where principal or interest payments are 30 days overdue or when there's substantial doubt regarding their collection. An uptick in this ratio could indicate increasing credit risk, but current data suggests stability in this area. Currently, loans in non-accrual status account for just 0.9% of Ares Capital's total investments at fair value, a slight improvement from 1% at the end of the previous quarter.

One way Ares mitigates some of this risk is by investing in first-lien or second-lien senior secured loans, which account for 64% of its total loans. This positions it as one of the first creditors to be paid during liquidation events. It also has 566 companies in its portfolio, and its largest single investment is only 2% of its portfolio.

For now, concerns over credit quality are muted, but it's also worth noting that the first quarter didn't reflect the effect of trade tariffs. Investors should continue to monitor this in upcoming quarters as tariffs work their way through the economy.

Ares Capital has a long history of solid returns for investors

Ares has a proven track record of success across different economic environments. Since its founding in 2004, the company has delivered excellent total returns (including reinvested dividends) of 12.9% annually -- outperforming the S&P 500 index along the way.

ARCC Total Return Level data by YCharts.

Ares Capital Corporation is the largest BDC in the U.S. and has a 20-year lending history to middle-market companies. The company has extensive knowledge of key markets and industries and has invested $160 billion since its inception.

With a total addressable market of $5.4 trillion and a longer-term shift to alternative investments like private capital lending, ultra-high-yielding Ares Capital Corporation is well-positioned to grow and capitalize on future opportunities.

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Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.