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3 Reasons You Should Buy Ares Capital

Summary

BDCs can be a extremely challenging high-yield industry in which to find long-term investing success.

Ares Capital is the largest BDC, with a great track record of growing shareholder wealth over time.

The American Capital Merger is poised to turn Ares Capital into an unbeatable titan of the industry, with significant competitive advantages that should keep the dividend highly secure.

Better yet, several key initiatives by management could bring about a return to sustainable dividend growth, especially if interest rates rise.

BUT there are 2 risks you need to know about before buying shares in this blue chip BDC.

With interest rates at their lowest level in history, income investors have good reason to feel frustrated, since bond yields have now fallen to ludicrously low levels that simply can't meet many people's needs.

Which is why many dividend lovers are drawn to business development corporations, or BDCs. These pass through entities act as private equity funds, though mostly they focus on lending to small, or middle market companies that can't meet the lending standards of traditional banks.

Of course that means taking on more credit risk, and as we've seen from the financial crisis, leveraged sub-prime lending can be a highly profitable endeavor...until it isn't. The inevitable economic downturn can lead to: rising default rates, crashing NAV, falling cash flows, dividend cuts, and large investor losses.

This is why anyone choosing to seek high-yield in the BDC space needs to be very selective, and only invest with proven management teams with solid track records of creating shareholder wealth.

ARCC Total Return Price data by YCharts

I've previously written about Main Street Capital (NYSE:MAIN), which I consider to be the gold standard of BDCs, explaining why I own it in my own dividend portfolio.

After much research, I've also recently added Ares Capital (NASDAQ:ARCC), for three main reasons. Let's take a look at what makes Ares Capital a standout in the BDC industry, and more importantly, why it might be just the high-quality, high-yield kick your own income portfolio is looking for.

Consistency in times of extreme industry stress

(click to enlarge)


Source: Ares Capital earnings presentation.

Thanks to interest rates continuing to decline over the past few years, as well as the low barriers to entry inherent to the BDC industry, EPS, and NAV growth has become increasingly difficult to come by.

Fortunately Ares Capital's management team has managed to maintain tight discipline in its lending standards. This has allowed it to avoid the kind of NAV erosion that rivals such as Prospect Capital (NASDAQ:PSEC), and TICC Capital (NASDAQ:TICC) have faced, especially as the oil crash has resulted in severe distress in BDC energy holdings.

ARCC Book Value (Per Share) data by YCharts

This is especially important because it helps to maintain long-term dividend security, and...


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