Top Picks 2007: Ares grows dividends for Carla Pasternak

Posted Dec 24th 2006 2:30PM by Steven Halpern
Filed under: Newsletters, ETF Investing

Each year, Steven Halpern, editor of TheStockAdvisors.com, surveys the leading financial newsletter advisors asking for their favorite stocks for the coming year. This article is part of his 24th annual Top Stocks Report.

Ares Capital (NASDAQ: ARCC) is the favorite speculative stock for 2007 from income specialist Carla Pasternak. The editor of High Yield Investing says, "Ares is a business development company that invests in private or thinly traded companies.

"Known as BDCs, these companies either buy an equity interest in promising firms, or they provide them with loans at above-average rates. Since going public in October 2004, Ares has built a $900 million portfolio of debt and equity securities, with a take in about 50 privately owned businesses.

"Ares is one of the fastest dividend growers I have seen. It has raised its dividend every single quarter for the past year, and its quarterly payouts have increased 33% in just two short years since the company paid its first dividend.

"If you annualize Ares' latest declared quarterly dividend of $0.40 per share, that brings the security's payout to $1.60 per share ($0.40 x 4 payments), giving the stock a forward yield of 8.3%. However, if you add in the $0.10 special dividend paid at the end of 2006, ARCC yields 8.8%.

"As a business development company, ARCC doesn't pay corporate taxes because it distributes most of its taxable income to shareholders. The capital gains portion of the dividend is taxable as long-term capital gains, but the rest of the dividend is taxed at your ordinary income tax rate. As such, this security is best held in a tax-deferred IRA or Roth account.

"Since going public in October 2004, Ares has raked in $35 million in capital gains on 15 investments totaling $250 million and has generated an astounding internal rate of return of 31% on these investments. With a P/E of 11 times next year's earnings, ARCC seems attractively priced.

"That said, the shares are trading at a significant premium to the portfolio's net asset value per share. I also recognize a short performance track record, the uncertain credit rating of companies within its portfolio, and constraints on its ability to raise additional capital. These are some of the factors that make this BDC a higher-risk idea."

To see Carla's favorite conservative investment for 2007, click here.