We recently published an article on 10 Best BDC Stocks To Invest In. In this article we will look at where Ares Capital Corporation (NASDAQ:ARCC) ranks among the 10 best BDC stocks.

Business Development Companies (BDCs) represent a compelling investment option for those looking to support smaller enterprises while earning a steady income through high dividend yields. BDCs operate as closed-end investment firms, specializing in providing much-needed capital to small and mid-size businesses that often face challenges accessing traditional sources of funding, such as bank loans or public equity markets. This unique business model allows BDCs to fill an essential gap in the financial ecosystem, supporting companies in various stages of development, including those undergoing turnarounds, experiencing financial distress, or poised for growth.

Established under the Investment Company Act of 1940, BDCs are required to meet specific regulatory standards, including maintaining registration with the Securities and Exchange Commission (SEC). What sets BDCs apart from private equity or venture capital firms is that they are publicly traded, giving regular investors access to an asset class that was once reserved for accredited or institutional investors. To qualify as a BDC, a company must allocate at least 70% of its assets to investments in privately-held or publicly-traded firms with market capitalizations below $250 million. This structure positions BDCs to invest in businesses that can benefit from their expertise and financial resources, generating returns for both the BDC and its investors.

One of the most attractive features of BDCs is their potential for generating income. Many BDCs offer dividend yields above 5%, with some even exceeding 10%. These high yields make them particularly appealing to income-focused investors. However, it’s important to approach BDC investments with careful due diligence, as high dividend yields can sometimes mask underlying financial issues. Investors need to ensure that a BDC’s portfolio and business fundamentals are strong enough to support consistent dividend payments without risking cuts in the future.

BDCs often rely on debt to finance their investments, which introduces leverage into their business models. This leverage can amplify returns during favorable economic conditions, allowing BDCs to maximize the value of their investments. However, leverage can also work against them during economic downturns, magnifying losses and putting pressure on their balance sheets. As a result, BDCs can be more volatile compared to other income-generating investments, particularly during periods of market turbulence.

Interest rates also play a significant role in the performance of BDCs. Since many BDCs borrow funds to invest, rising interest rates can increase their borrowing costs, potentially cutting into profits and reducing the overall returns to investors. Credit risk is another important factor to consider, as BDCs typically invest in smaller businesses that may be more vulnerable to financial instability or default. Analyzing the quality of a BDC’s portfolio and its risk management practices is crucial for investors looking to avoid excessive losses.

Tax considerations are another factor that makes BDCs unique. BDCs are required by law to distribute at least 90% of their taxable income to shareholders, which is why they often offer such high dividend yields. However, BDC dividends are not typically classified as “qualified dividends,” meaning they are taxed at ordinary income rates rather than the lower rates applicable to qualified dividends. For this reason, BDC investments may be better suited to tax-advantaged retirement accounts like IRAs or 401(k)s, where the tax impact can be minimized.

Despite these complexities, BDCs remain an attractive option for many investors, particularly those seeking high yields and exposure to a diverse range of smaller companies. For those willing to carefully evaluate the risks, BDCs offer the potential for both income and capital appreciation. In the following sections, we will highlight ten of the best BDC stocks to consider for your portfolio, analyzing their dividend yields, financial health, and overall investment potential. Whether you’re a seasoned income investor or new to BDCs, these stocks could provide valuable opportunities for steady returns in today’s market.

Our Methodology

We sifted through online rankings and ETFs to come up with a preliminary list of 15 BDC stocks. We then examined Insider Monkey’s data on over 900 hedge funds, as of Q2 2024, and picked the 10 that were the most popular among elite hedge funds. The stocks are sorted in ascending order of the number of hedge funds that have stakes in them.

At Insider Monkey we are obsessed with the stocks that hedge funds pile into. The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).

Ares Capital Corporation (NASDAQ:ARCC)

Number of Hedge Fund Holders: 16

Ares Capital Corporation (NASDAQ:ARCC) stands out as a leading choice among Business Development Companies (BDCs) due to its comprehensive approach to providing capital and its consistent track record of delivering strong financial performance. As a BDC, Ares Capital specializes in investing in middle-market companies across various sectors including manufacturing, healthcare, and technology. Its diversified investment strategy, which includes acquisition, recapitalization, and mezzanine debt, positions it well to capitalize on evolving market opportunities. The company’s robust investment platform and strategic regional focus enhance its ability to generate attractive returns and provide capital solutions across a broad spectrum of industries.

In the second quarter of 2024, Ares Capital Corporation exceeded earnings expectations, reporting core earnings per share (EPS) of $0.61, surpassing the anticipated $0.58. This represents a 5% increase year-over-year, underscoring the company’s solid performance amidst a competitive market. The positive financial results were driven by a favorable investment environment, healthy credit performance, and a significant increase in deal flow. The company achieved a record net asset value (NAV) per share of $19.61, reflecting a 6% year-over-year growth.

Ares Capital Corporation (NASDAQ:ARCC) financial metrics highlight its strong position in the market. The company’s portfolio at fair value grew to $25 billion, up from $23 billion in the previous quarter, showcasing its active investment strategy. The weighted average yield on its debt and income-producing securities remained stable at 12.2%, with an overall yield on investments at 11.1%. This demonstrates the company’s ability to maintain high returns on its investments despite market fluctuations. The company declared a quarterly dividend of $0.48 per share, marking its 15th consecutive year of stable or increasing dividends. This yield is supported by a strong taxable income spillover, estimated at $635 million or $1.05 per share for 2024, providing further stability and visibility for investors.

In summary, Ares Capital Corporation (NASDAQ:ARCC) impressive financial performance, strategic investment approach, and robust dividend yield make it a compelling addition to any portfolio focused on BDC stocks. Its consistent ability to deliver strong returns and maintain a high dividend yield underscores its appeal as a top investment choice in the BDC sector.

Overall, ARCC ranks 3rd on our list of the best BDC stocks to buy. While we acknowledge the potential of ARCC as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than ARCC but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

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Disclosure: None. This post was originally published on Insider Monkey.