ARCC - Looking For Yield? Growth? These 2 Stocks Give Your Portfolio A Little Bit Of Both

2023-12-12 16:00:57 ET

Summary

• Agree Realty and Ares Capital are two perfect stocks for investors looking for a balanced dividend portfolio of yield & growth.
• Although the current macro environment has placed downward pressures on several businesses, both have navigated the rough seas and continue to pay safe dividends.
• Both stocks' share prices have appreciated over the last month after as investor sentiment seems to be shifting towards potential rate cuts in the near future.
• The next FOMC meeting could cause the market to experience some short-term volatility if the FED chair decides to push back against a potential rate cut.

Introduction

The next FOMC meeting will determine which way the market will go for the next few weeks, in my opinion. If the FED chair pushes back on potential rate cuts and decides to surprise investors with a hike, then I expect the market to react negatively. If rates are held and the higher for longer environment is reiterated, this could also lead to the stock market volatility. There's a less likely chance that we will get some great news during this month's meeting. Yes, the recent jobs report came out better than expected with more than 190,000 added jobs, but inflation is expected to stay flat and remain elevated above the 2% target.

A lot of dividend investors like stocks with high, attractive yields such as Business Development Companies (BDCs) or those with fast-growing dividends from tech stocks, or other well-established dividend paying companies. My motto is always: Why have or focus on one when you can have both? In this article, I list two stocks from different sectors that give investors' portfolios both a high, sustainable yield, and a growing monthly dividend to help build balance their portfolio with not only yield, but some growth as well.

#1 Ares Capital

I last talked about Ares Capital ( ARCC ) back in October, where I rated the stock a strong buy due to their earnings beat and valuation at the time. Since then, the stock's price has appreciated to over $20 a share as investors search for safe, higher-yielding alternatives to bonds and CDs. With these still offering attractive yields currently, this has caused several BDCs to move to fair or overvalued territory. ARCC, at the time of writing, offers a safe yield near 10%, so you can see why the price has appreciated in the last couple of months.

I've held ARCC for quite some time but have not added to it or any of my BDC positions recently because of their valuations. If you're an investor looking for a high yield, BDCs or stocks like Altria ( MO ) are usually the first choices. When considering holding a stock in my portfolio, one thing I always try to maintain is balance. I am not a day or swing trader, as that takes too much time and makes one emotionally tied to their holdings. I often think of quotes from Warren Buffett when things start to get tough in the market.

I'll admit I can be slightly emotional and ask myself questions in regard to the market sometimes. Having balance and keeping these in check allows me to navigate those emotions with a portfolio that is well-balanced. I'm not a yield chaser, but I do have stocks that have yields in the upper single to double-digits like ARCC. But the most important question with high-yielders I typically ask is: Is the dividend safe and sustainable for the long-term? I don't plan on selling my stocks unless the fundamentals change, but doing your due diligence and selecting quality ones that offer a high yield is key.

With a yield of 9.71% currently, one may think a yield nearing double-digits is automatically unsustainable. But during ARCC's third quarter, they continued to perform conservatively like they always do. Net investment income fell from the previous quarter, but still continued to out-earn its dividend by nearly 23%! So, not only did they do this impressively in the last quarter, they also decreased their leverage to 1.03x and had ample liquidity to cover the $1.3 billion in debt due next year.

One of the things I like about ARCC is that the BDC likes to carry over extra income from the previous year. So, instead of paying out their extra income in the form of specials and supplementals, management prefers to keep it. This allows them to use the extra income to cover the dividend if they ever get into a financial bind or face unexpected headwinds for a sustained period. As you can see from the chart below, ARCC carried over $643 million in spillover income into 2023 and in Q4 I expect management to announce their spillover for 2024.

#2 Agree Realty

Agree Realty ( ADC ) is one of my absolute favorite REITs and I last covered them back in November. The sector experienced some headwinds a couple of months back, but now seems to be leveling off. One reason is because Mr. Market is likely expecting a potential rate cut sometime in 2024. As you can see below, ADC is up 3.53% in the last month. More than a week ago the price moved above $60 which it hadn't seen since September.

I've been adding heavily to my position to lower my cost basis as the stock has dropped to the low $50's recently, hitting a new 52-week low before bouncing back above $60 earlier this month. Some may not consider REITs to be growth investments, but I disagree. Of course, they don't offer the same high double-digit growth as say a Starbucks ( SBUX ), but what they do typically offer is steady single-digit growth. On top of that, with Agree Realty, you get a growing monthly dividend that is well-covered by a 76% payout ratio, well-below the REIT average of 90%.

During their latest earnings, ADC beat FFO estimates by a penny. Additionally, they also managed to raise their guidance despite the volatility and secular headwinds. Their portfolio is also well occupied at 99.7%, one of the highest amongst their peers. So, some investors may be asking the question, with REITs being considered low-growth income vehicles, how can one expect growth with their usual lower yields? Well, ADC's CEO stated during Q3 earnings that the REIT expects to deliver 3% growth over the next year with no acquisitions or any new capital deployed. And with a dividend yield of nearly 5%, you get nearly 8% when you include the 3% expected growth rate.

Risk Factors For Both

Although both stocks are in two completely different sectors, they still face similar risks from the current macro environment. One is elevated interest rates, or the possibility of another rate hike. I'm not in no way saying I know what's going to happen during the December 12-13 meeting next week, but I do expect the FED chair to push back on the evolving sentiment of a rate cut. If rates remain elevated throughout 2024, or they decide to raise, this will place a tremendous amount of stress on both businesses' portfolio tenants. This could potentially lead to a decline in revenue for both as the risk for rent/loans defaults rise.

While I do still expect one in the coming year, investor and market sentiment could take a blow next week if they do decide to hold or raise rates further. The recent job report added more jobs than expected last month, which I believe shifted the overall market sentiment recently, as seen by the rise in stock prices.

But, I expect Jerome Powell to continue to leave the door open for more potential hikes down the line as data continues to come in the coming months. With the market expecting more than a 97% chance rates stay here, I think the market reaction (good or bad) will depend more on what Powell says at the upcoming meeting more than anything. And while many analysts are leaning toward a soft landing, others predict a mild recession in 2024 or 2025.

Valuation

As you can see, both are in the green slightly over the last month. This is in comparison to the S&P, up roughly 5% over the same period. In my last articles on both, I rated both stocks a strong buy due to their low valuations. While Wall Street analysts currently rate ARCC a buy and ADC a strong buy, I rate both a hold due to ARCC's share price nearly 6% above its NAV, giving investors barely any upside to their price target . Regarding ADC, they still offer some upside to their price target of roughly $66. But those looking for a greater margin of safety should wait for a potential pullback in price if looking to add. I preferably like the price under $55 and depending on the next meeting, investors could see the stock price fall near or below this price.

Investor Takeaway

Investors looking for balance in their dividend portfolios should consider adding these two stocks on a pullback in price or any signs of share price weakness. Although sentiment seems to have shifted positively in the last month, the next FOMC meeting could cause some volatility in the market as I expect the FED chair to provide some pushback on potential rate cuts next year. If so, that could potentially be a great time to add if both companies experience decline. Even with the current macro environment continuing to place downward pressures on several businesses, both ARCC and ADC are amongst the highest of quality when it comes to their sectors and their peers.

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