Investors looking to pad their passive income streams have some excellent options to choose from these days. Fear of a recession that may or may not occur keeps pushing down the prices of these dividend-paying stocks and raising the yields they offer.
Following over a year of dramatic interest rate raises the Federal Reserve’s November meeting was the second time in a row that central bankers took no action. Easing inflation is great news for these dividend-paying stocks that offer high yields now.
These dividend payers appear stable in the present rate environment, which means their payouts could rocket higher if the Federal Reserve decides it went too far and starts lowering rates in 2024.
Ares Capital Corporation
Ares Capital Corporation (ARCC 0.10%) is a business development company (BDC) that offers shareholders a huge 9.8% dividend yield at recent prices. BDCs exist to serve midsize businesses that are large enough to have legitimate capital requirements but still too small to attract the attention of America’s largest banks.
Mid-sized businesses starved for capital are willing to borrow from Ares at variable interest rates that were fairly high to begin with. The average yield on its total investment portfolio rose to 11.2% at the end of September from 10.5% at the end of 2022.
During previous economic cycles, we’ve seen rapidly rising interest rates turn overheated economies icy cold in a heartbeat. Inflation and rising interest expenses are already squeezing Ares Capital’s borrowers into tight spots. A deep and lasting recession could finish off too many at once and lead to a dividend cut. These fears are keeping the stock price so low that it offers an eye-popping dividend yield.
Ares Capital didn’t become America’s biggest BDC by lending capital to anyone who comes calling. This lender prefers borrowers with reliable cash flows plus partnerships with known private equity sponsors. Ares Capital’s underwriting team deserves a medal for its activity this year. At the end of September, loans on non-accrual status represented 1.2% of total investments at cost, compared with 1.7% at the end of 2022.
Ares Capital earned $0.89 per share in the third quarter, which is heaps more than it needs to meet a quarterly dividend commitment currently set at $0.48 per share. A deep and prolonged recession could eventually force the BDC to lower its dividend payout but this looks like a risk worth taking.
Ally Financial (ALLY 1.29%) is America’s oldest all-digital bank. Until a little over a decade ago, it was the financial arm of General Motors, and it’s still building relationships with automobile dealerships.
Fear of a recession is keeping Ally Financial shares under pressure. The stock has been trading for the ultra-low price of about 0.9 times its tangible book value.
At recent prices, Ally Financial shares offer a juicy 4.3% yield that could shoot much higher if the recession everyone’s afraid of doesn’t materialize. Over the past year, the bank met its dividend commitment with just 38.7% of the profit it earned.
So far, Ally Financial’s retail auto loan net charge-off rate is low at 1.85% and suggests it can weather a storm. The bank appears well capitalized, with a Common Equity Tier 1 (CET1) ratio of 9.3%, which is more than double the minimum ratio mandated by the U.S. government.
Ally Financial held its dividend in place this year and will probably do the same in 2024 if the recession everyone fears actually happens. If we get lucky and the slowing economy lands softly, though, investors could see the yield on their original investment soar. Pretax profits from dealer financial services are down this year, but the company reported a record level of auto loan applications in the third quarter. Adding shares to a portfolio now to hold forever looks like the right call.
Ally is an advertising partner of The Ascent, a Motley Fool company. Cory Renauer has positions in Ally Financial. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.