Ares Capital Corporation (NASDAQ:ARCC) shares are down more than -0.49% this year and recently increased 0.12% or $0.02 to settle at $16.41. FS Investment Corporation (NYSE:FSIC), on the other hand, is down -17.48% year to date as of 10/02/2017. It currently trades at $8.50 and has returned 4.94% during the past week.
Ares Capital Corporation (NASDAQ:ARCC) and FS Investment Corporation (NYSE:FSIC) are the two most active stocks in the Diversified Investments industry based on today’s trading volumes. Investor interest in the two stocks is clearly very high, but which is the better investment? To answer this question, we will compare the two companies across growth, profitability, risk, and valuation metrics, and also examine their analyst ratings and insider activity trends.
Companies that can increase earnings at a high compound rate over time are attractive to investors. Analysts expect ARCC to grow earnings at a 3.00% annual rate over the next 5 years. Comparatively, FSIC is expected to grow at a 3.00% annual rate. All else equal, All else equal, the two stocks’ identical expected growth rates would imply a similar potential for capital appreciation..
Profitability and Returns
Just, if not more, important than the growth rate is the quality of that growth. Growth can actual be harmful to investors if it comes at the cost of weak profitability and low returns. To adjust for differences in capital structure we’ll use EBITDA margin and Return on Investment (ROI) as measures of profitability and return. ARCC’s ROI is 5.50% while FSIC has a ROI of 5.20%. The interpretation is that ARCC’s business generates a higher return on investment than FSIC’s.
Cash is king when it comes to investing. ARCC’s free cash flow (“FCF”) per share for the trailing twelve months was +0.08. Comparatively, FSIC’s free cash flow per share was +0.80. On a percent-of-sales basis, ARCC’s free cash flow was 3.38% while FSIC converted INF% of its revenues into cash flow. This means that, for a given level of sales, ARCC is able to generate more free cash flow for investors.
Liquidity and Financial Risk
Analysts look at liquidity and leverage ratios to assess how easily a company can cover its liabilities. ARCC’s debt-to-equity ratio is 0.69 versus a D/E of 0.75 for FSIC. FSIC is therefore the more solvent of the two companies, and has lower financial risk.
ARCC trades at a forward P/E of 10.24, a P/B of 0.99, and a P/S of 6.49, compared to a forward P/E of 10.32, a P/B of 0.91, and a P/S of 5.03 for FSIC. ARCC is the cheaper of the two stocks on an earnings basis but is expensive in terms of P/B and P/S ratio. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.
Analyst Price Targets and Opinions
Investors often compare a stock’s current price to an analyst price target to get a sense of the potential upside within the next year. ARCC is currently priced at a -9.54% to its one-year price target of $18.14. Comparatively, FSIC is -6.59% relative to its price target of $9.10. This suggests that ARCC is the better investment over the next year.
The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 2.00 for ARCC and 3.00 for FSIC, which implies that analysts are more bullish on the outlook for FSIC.
Risk and Volatility
Analyst use beta to measure a stock’s volatility relative to the overall market. Stocks with a beta above 1 tend to have bigger swings in price than the market as a whole, the opposite being the case for stocks with a beta below 1. ARCC has a beta of 0.66 and FSIC’s beta is 0.99. ARCC’s shares are therefore the less volatile of the two stocks.
Ares Capital Corporation (NASDAQ:ARCC) beats FS Investment Corporation (NYSE:FSIC) on a total of 8 of the 14 factors compared between the two stocks. ARCC generates a higher return on investment, has a higher cash conversion rate, higher liquidity and has lower financial risk.