Ares Capital (NASDAQ: ARCC) stock price has recovered modestly from its lowest point in March. The stock ended the month at $18.28, ~7.4% above the lowest point in 2023. In all, ARCC has generated weak returns in the past few months after dropping by 20% from its highest point in 2022. It has still risen by ~70% in the past three years.
Is the 10.5% forward yield safe?
Ares Capital is a Business Development Company (BDC) that provides loans to companies in most American sectors. The firm is managed by Ares Capital Management, a large private equity company with over $352 billion in assets under management (AUM).
As a BDC, Ares Capital investors in first lien secured loansand secod lien senior secured loans. Notably, the company’s loans are free floating, meaning that they adjust based on the Fed interest rates. As a result, to a large extent, the company benefits when interest rates are rising.
ARCC also has mechanisms to ensure that it makes money in era of low interest rates. The mechanism is known as a floor, which ensures that most of its loans are profitable. It also explains why the company did well in an era of low-interest rates.
Most Ares Capital investors do so because of the company’s dividends. The firm has a forward dividend yield of ~10.5%, which is higher than what cash is yielding today and inflation. In an era of high interest rates and inflation, having cash in high-yielding instruments makes sense. In this regard, ARCC has increased its dividends in the past 13 years and it could hike this year.
Another reason why ARCC seems like a good investment is its diversification. Most of its investments, ~22%, is in software & services folloewed by Ivy Hill Asset Management, Healthcare services, Commercial & Professional services, and insurance. This diversification explains why the company did well during the Covid-19 pandemic.
A key challenge that many BDCs have is that many are highly leveraged, especially when interest rates are rising. ARCC is a bit safe since it does not have any maturities this year. The upcoming maturity will be $1.3 billion in 2024. But the pricing of the bond market shows that investors are not concerned about its ability to pay.
Ares Capital stock price forecast
ARCC chart by TradingView
The daily chart shows that the ARCC stock price has risen in the past few days. It has managed to move above the key resistance point at $17.96, the lowest point on December 19th. It remains below the descending trendline shown in green.
The stock is slightly below the 50-day exponential moving average. It seems like it has formed an inverted head and shoulders pattern, which is a bullish sign.
Therefore, the stock will likely continue rising as buyers target the descending trendline at ~20. A move below the support at $17.90 will invalidate the bullish view.
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