This Ultra-High-Yield Dividend Stock in Warren Buffett's Secret Portfolio Is a No-Brainer Buy

Keith Speights, The Motley Fool

Mon, Nov 18, 2024, 2:46 AM 4 min read

You'll only find one ultra-high-yield dividend stock in Berkshire Hathaway's (NYSE: BRK.A) (NYSE: BRK.B) quarterly 13-F regulatory filings: Kraft Heinz. The definition I use for ultra-high yield, by the way, is four times the yield of the S&P 500. A forward dividend yield of roughly 4.92% is required to meet that threshold right now.

However, Warren Buffett and Berkshire Hathaway own more stocks than those regulatory filings disclose. At least one ultra-high-yield dividend stock in Buffett's "secret portfolio" is a no-brainer buy right now.

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A capital idea

There's nothing shady about Buffett's "secret portfolio." Actually, while many people aren't aware of it, the portfolio isn't much of a secret.

In 1998, Berkshire Hathaway acquired reinsurance company General Re. Around three years earlier, General Re bought New England Asset Management (NEAM). NEAM offers asset management services to the insurance industry and manages a separate portfolio from Berkshire Hathaway's. Like its parent company, NEAM discloses its holdings each quarter.

NEAM's portfolio includes several stocks that pay dividends that meet my definition of ultra-high yield. I think several of them are such good picks that I own them too. Ares Capital (NASDAQ: ARCC) ranks as one of the best, in my view.

Ares Capital is a leading business development company (BDC). It invests in and provides direct lending to middle-market businesses that generate annual revenue between $10 million and $1 billion. NEAM (and, by extension, Buffett and Berkshire) own 225,900 shares of Ares Capital worth in the ballpark of $4.9 million.

Why Ares Capital is a no-brainer buy

The most glaring plus for Ares Capital is its forward dividend yield of 8.9%. Why is this yield so high? As a BDC, Ares Capital must return at least 90% of its earnings to shareholders as dividends. With a brief exception in 2020 due to the COVID-19 pandemic, the company's earnings have been solid in recent years.

I like the diversification of Ares Capital's $25.9 billion portfolio. In the third quarter of 2024, the company's largest investment made up only 1.7% of its total portfolio. Its top 10 investments comprised 11.3% of the total. Also, no industry made up greater than 25% of Ares Capital's portfolio.

Importantly, Ares Capital only provides financing to fundamentally strong companies with good management teams. It especially targets companies in resilient, non-cyclical industries.

Ares Capital's own access to capital -- a mission-critical prerequisite for a BDC -- is secure. The company has investment-grade credit ratings with positive to stable outlooks from the leading credit rating agencies. It has relationships with 43 banks and over 250 investors in the capital markets. Ares currently has $5.8 billion of available liquidity.

The company's track record speaks for itself. Ares Capital's total return since its formation in 2004 tops 1,000% versus a total return of around 680% for the S&P 500 during the same period. That translates to an annualized total return of roughly 13%. Over the last 10 years, Ares has increased its dividend by 26.3% -- more than any other externally managed BDC with a market cap of over $700 million that has been publicly traded throughout the entire period.

Key risks

While I think Ares Capital is a no-brainer stock to buy for many investors, the company faces some key risks. The BDC's occasional use of leverage (borrowing money to increase its returns to shareholders) ranks near the top of the list.

Another risk with Ares Capital is that its clients could default on repaying their loans. This comes with the territory of operating as a BDC. However, I think Ares' portfolio diversification and stringent criteria for its investments help mitigate this risk to a great extent.

There's also a real possibility that capital markets could experience disruption. Wars, epidemics and pandemics, skyrocketing inflation, and/or surging interest rates could cause significant problems for Ares Capital's business. That said, the company has navigated these kinds of challenges quite well in the past.

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Keith Speights has positions in Ares Capital and Berkshire Hathaway. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool has a disclosure policy.

This Ultra-High-Yield Dividend Stock in Warren Buffett's Secret Portfolio Is a No-Brainer Buy was originally published by The Motley Fool

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