Business Development Company Now Yields Almost 10%
Business might be slow in August as many people take their vacations. But according to a Wall Street investment bank, there is an “August Opportunity” for income investors.
In a note to investors, Keef, Bruyette & Woods analyst Ryan Lynch said that Ares Capital Corporation (NASDAQ:ARCC) stock should be a core holdings. (Source: “KBW: Ares Capital Is an August Opportunity,” Barron’s, August 23, 2016.)
Ares Capital Corporation is a business development company (BDC) that provides debt and equity financing to middle market companies, venture capital backed businesses, and power generation projects in the U.S. As of the end of March 2016, Ares Capital is the largest BDC by total assets and market capitalization.
The U.S. Congress created BDCs in 1980 to help raise funds for startup businesses and boost employment growth. BDCs are different from venture capital companies in that they allow smaller, non-accredited investors to invest in emerging companies.
The analyst has an “outperform” rating on Ares Capital with a price target of $17.50. This represents a seven percent potential upside from the stock’s current level. At today’s price, Ares Capital now yields 9.54%.
Lynch wrote that Ares Capital’s solid credit quality, high return on equity (ROE), and a compelling valuation make it a core holding. Moreover, the BDC could also benefit from its planned acquisition of American Capital Ltd. (NASDAQ:ACAS).
When it comes to valuation, the analyst pointed out that Ares Capital is trading at a 14% discount compared to its peers on a price-to-book ratio metric and at a six-percent discount on a price-to-earnings metric.
“Not only is ARCC trading at a discount to its peers, they are also trading at a discounted valuation relative to where they have historically traded from both P/B and P/E metrics,” he wrote. “To summarize, ARCC’s valuation looks compelling both compared peers and compared to their own historical valuation multiples.” (Source: Ibid.)
His conclusion: “ARCC’s excellent credit underwriting has allowed them to generate one of the highest ROEs in the group but the market is currently valuing their stock at a discount.”