Chasing Yield Is Fraught With Risk

Let’s See If We Can Help This Couple

In order to help this couple avoid the pitfalls of investing in high dividend yield companies of dubious quality, we start by looking at the daily treasury yield curve rates.

Daily Treasury Yield Rates

Our next step is to select 3 companies from Sure Dividend’s list of companies with 5%+ dividend yields.

We decide to:

  • Exclude companies with market caps under $2B and in excess of $50B. The rationale for excluding these companies is that sub $2B market cap companies typically are thinly traded. In addition, this couple is retired so we want to avoid companies that would likely be more susceptible to encounter financial difficulty in the event of an economic downturn;
  • Excluded $50B+ market cap companies as they typically have far more levers to pull in order to strengthen their financial position. These mega-cap companies (eg. AT&T) are likely to have a sustainable dividend (that does not mean it will grow quickly) and would very likely be suitable investments;
  • Eliminated companies based outside the United States. Sure Dividend’s list of companies includes foreign companies but these stocks are typically thinly traded in the US;
  • Removed companies with an average trading volume under 1Million shares. This threshold was arbitrarily set for the purposes of identifying 3 companies.

After narrowing down the universe of companies, we decide not to select the highest dividend yielding companies from this subset and to avoid selecting companies which are all in the same sector.

Our 3 Subject Companies

In this section we perform a very high-level overview of the financial statements, stocks charts, and dividend track record for 3 companies; we do not perform a comprehensive industry and business review.

Ares Capital Corporation

  • Market Cap: $6.74B
  • Average Daily Volume: 1.77 Million shares
  • Dividend Yield: 9.69%
  • Additional metrics can be found here.

Ares Capital Corporation (ARCC ) is a specialty finance company that is a closed-end non-diversified management investment company; it is regulated as a business development company (BDC). It provides one-stop solutions to meet the distinct and underserved financing needs of private middle-market companies across diverse industries.

ARCC was founded April 16, 2004, and completed its initial public offering (“IPO”) on October 8, 2004. It is one of the largest BDCs in the US with approximately over $9B of total assets.

Its investment objective is to generate both current income and capital appreciation through debt and equity investments. ARCC invests primarily in U.S. middle-market companies, where it believes the supply of primary capital is limited and the investment opportunities are most attractive. It may, however, periodically invest in larger or smaller (in particular, for investments in early-stage and/or venture capital-backed) companies.

Our couple would be well advised to closely read ARCC’s December 31, 2016, 10-K with particular attention being paid to page 3 of 241 where ARCC indicates its investments are speculative in nature.

“The first and second lien senior secured loans in which we invest generally have stated terms of three to 10 years and the mezzanine debt investments in which we invest generally have stated terms of up to 10 years, but the expected average life of such first and second lien loans and mezzanine debt is generally between three and seven years. However, we may invest in loans and securities with any maturity or duration.

The instruments in which we invest typically are not rated by any rating agency, but we believe that if such instruments were rated, they would be below investment grade (rated lower than “Baa3” by Moody’s Investors Service, lower than “BBB–” by Fitch Ratings or lower than “BBB–” by Standard & Poor’s Ratings Services), which, under the guidelines established by these entities, is an indication of having predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. Bonds that are rated below investment grade are sometimes referred to as “high yield bonds” or “junk bonds.” We may invest without limit in debt or other securities of any rating, as well as debt or other securities that have not been rated by any nationally recognized statistical rating organization.”[emphasis added].

If that is insufficient cause for concern for our couple, we encourage them to review ARCC’s Consolidated Schedule of Investments which commences on page 126 of 241 of the 10-K. Our couple reviews same and notes that most of ARCC’s borrowers are paying high single digit and low double-digit interest rates on their loans!

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Disclosure: Sure Dividend is published as an information service. It includes opinions as to buying, selling and holding various stocks and other securities.

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