If you're eager to build a passive income stream that can fuel your retirement dreams, you may have noticed it's getting harder and harder to find stocks that pay satisfying dividend yields.
The S&P 500 has risen about 31% over the past 12 months. With prices going through the roof, the average dividend-paying stock in the benchmark index offers an unattractive 1.3% yield.
It's harder to find high-yield stocks that investors can rely on, but it isn't impossible. Right now, Ares Capital(NASDAQ: ARCC) and PennantPark Floating Rate Capital(NYSE: PFLT) offer yields above 9%, and there's a pretty good chance that they'll be able to maintain their payouts over the long term.
1. Ares Capital
Ares Capital is the world's largest publicly traded business development company (BDC). These specialized entities are popular among income-seeking investors because they can avoid paying income taxes by distributing nearly all of their earnings to shareholders in the form of dividend payments.
Ares Capital's dividend payout hasn't risen in a straight line, but it is up by 60% since the company began distributing earnings in 2005. At recent prices, the stock offers an attractive 9.2% dividend yield.
North American banks have been dialing back their direct lending exposure to all but the largest companies for decades. As a result, heaps of well-run midsize businesses are starving for capital and willing to pay eye-popping interest rates.
In the second quarter, the average yield on debt securities in Ares Capital's portfolio was 12.2% at cost. As a well-established BDC, it has a fairly low cost of capital. It paid an average interest rate of 5.3% on outstanding debt in the second quarter.
A wide gap between Ares Capital's income and its interest expenses pushed second-quarter core earnings up by 5% year over year to $0.61 per share. That's more than the company needs to meet a quarterly dividend obligation currently set at $0.48 per share.
The are no guarantees, but Ares Capital's portfolio of debt securities seems highly likely to continue supporting its high-yield dividend payment. There were 525 borrowers in the BDC's portfolio at the end of June, but hardly any are having trouble making ends meet. Loans on nonaccrual status represented just 1.5% of total investments at cost.
Severe economic downturns can pressure BDCs, but investors don't have to worry that any single industry will tank Ares Capital. Its heaviest concentration was in the software and services industry, at 24% of the overall portfolio.
2. PennantPark Floating Rate Capital
PennantPark Floating Rate Capital is another BDC with a diverse portfolio and an attractive dividend. With a brief exception in 2018, it's been making monthly dividend payments that have risen or remained steady since 2011. At recent prices, it offers a 10.7% yield.
This BDC is similar to Ares Capital, but there are some important differences. At the end of June, 50% of Ares Captial's assets were first-lien senior secured loans. Nearly all of PennantPark Floating Rate Capital's loans are first-lien senior secured debt, which means they're first in line to be repaid in the unlikely event of bankruptcy.
Around 31% of Ares Capital's investments are equity stakes or fixed-rate loans. Pennantark Floating Rate Capital doesn't have any fixed-rate debt on its books, and equity stakes account for just 13% of its portfolio.
PennantPark Floating Rate Capital's underwriting team isn't as large as Ares Capital's, but it's big enough to do the job well. To date, it's closed deals with midsize businesses represented by more than 230 private equity sponsors. At the end of June, just three of this BDC's portfolio companies, representing 1.5% of the portfolio at cost, were on nonaccrual status.
PennantPark Floating Rate Capital's operation is much smaller than Ares Capital's, but it's arguably more diversified. At the end of June, professional services was its largest industry concentration, at 7.8% of the portfolio. With a diverse portfolio of secured loans generating reliable cash flows, this BDC could maintain and raise its monthly dividend payment for many years to come.
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Cory Renauer has positions in Ares Capital. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
