How High Can Ares Capital Climb?

Next Tuesday, Ares Capital will release its latest quarterly results. The key to making smart investment decisions on stocks reporting earnings is to anticipate how they'll do before they announce results, leaving you fully prepared to respond quickly to whatever inevitable surprises arise. That way, you'll be less likely to make an uninformed, knee-jerk reaction to news that turns out to be exactly the wrong move.

As a business development company, Ares Capital has attracted a lot of attention due to its huge dividend yield. But lately, capital appreciation has played an even more vital role in the company's long-term returns. Let's take an early look at what's been happening with Ares Capital over the past quarter and what we're likely to see in its quarterly report.

Stats on Ares Capital

Source: Yahoo! Finance.

How will Ares Capital's earnings fare this quarter?
In recent months, analysts have gotten just the slightest bit more pessimistic about Ares Capital's earnings prospects, cutting a penny per share from their estimates for both the first quarter and the full 2013 year. But the stock has fared better, climbing 4% since late January.

Ares invests mostly in secured loans and senior debt, taking advantage of the BDC structure to avoid corporate-level tax. In exchange, it has to pay the bulk of its income to shareholders as dividends, producing the company's attractive yield of roughly 9%. That's been a huge draw for investors, who've been willing to pay up for BDC shares lately.

But one concern is that investors are paying too much for BDCs. Like Ares, peers Prospect Capital and Fifth Street Finance also carry share prices that are higher than the net value of the assets on their books. Yet Ares trades at a substantially higher premiums to NAV than Prospect or Fifth Street, suggesting that they're more comfortable with the quality of Ares' assets compared to its rivals.

Even a secondary stock offering back in April wasn't enough to send the stock downward for long, as the company offered more than 19 million shares to investors and underwriters at $17.43 per share. Yet despite the temporary decline of about 4%, the stock recovered all of its losses before the month was out.

In Ares Capital's quarterly report, pay close attention to how the company's net asset value has fared during the quarter. As a fundamental reflection of the health of the business, investors shouldn't be willing to pay too much of a premium for Ares shares no matter how attractive the dividend yield may be.

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The article How High Can Ares Capital Climb? originally appeared on Fool.com.

Fool contributor Dan Caplinger has no position in any stocks mentioned, and neither does The Motley Fool. You can follow him on Twitter @DanCaplinger. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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