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Main Street: High-Yield BDC With a Positive Outlook

·4 mins read

The decline in interest rates over the course of 2019 has put income investors in a difficult position. Investors who are looking for income from their stock portfolios have to widen their search, as the average yield of the S&P 500 Index has declined to below 2%.

Fortunately, there are still many high dividend stocks that provide investors with attractive income. Business development companies, or BDCs, are broadly appealing for their high dividend yields. We created a BDC list with rankings of our top picks for 2020.

Main Street Capital Corp. (NYSE:MAIN) has a positive outlook; and with a 5.6% dividend yield, the stock is attractive for income investors.

Business overview

Main Street Capital is a business development company. The BDC business model is to make money by investing in debt and equity securities issued by small companies. BDCs are appealing to many investors because they provide exposure to venture capital investments, which previously was only for professional investor groups.

Main Street primarily makes investments in companies with revenue between $10 million and $150 million, and earnings before interest, taxes, depreciation and amortization between $3 million and $20 million. Investments are comprised of first lien, senior secured debt and equity financing.

The company has an interest in nearly 70 lower middle-market companies, over 50 middle-market companies and over 60 private loan investments. The company has a market capitalization of $3 billion. Main Street had its initial public offering in 2007, and currently manages over $4.4 billion in capital.

The company's investment portfolio is broad and diverse. No individual industry group represents more than 8% of assets. The top industry groups are machinery, media, eonstruction and engineering, aerospace and defense, energy equipment and services and commercial services and supplies. Slightly more than 40% of investments are recapitalizations or refinancing. An almost equal amount is invested in leveraged buyouts.

In third-quarter 2019, net investment income was $39 million, a 2% increase compared to $38.1 million a year ago. The company generated net investment income of 62 cents per share, down 1.6% from last year's income of 63 cents. Distributable net investment income totaled 66 cents per share, identical to the third quarter of 2018. Main Street's net asset value increased 11 cents to $24.20 since the start of 2019, an increase of 0.5%.

One of the risks of the BDC business model is the use of leverage. To amplify returns, BDCs often take out debt. This can boost returns in bull markets and when the economy is growing. But use of leverage can backfire in a market downturn or recession. Investors must make sure the company has strong debt metrics. Main Street has a strong credit rating of BBB, which indicates a manageable debt level.

Attractive dividend payout

The most appealing feature of investing in BDCs is their high dividend yields. Indeed, Main Street has a 5.6% dividend yield right now, which is more than double the average dividend yield of the S&P 500 Index. Main Street is a monthly dividend stock, meaning it pays its dividends every month, while most stocks pay dividends less frequently (quarterly or semi-annually).

Main Street can distribute a high level of income to shareholders, in part because of its strong fundamentals. The company has grown distributable net investment income in each of the past five years. Distributable net investment income increased at a double-digit rate each year from 2014 to 2018.

And, Main Street has a good track record of stable dividend payouts. It has never decreased its monthly dividend rate. In addition, since July 2013, the company has paid a semi-annual supplemental dividend to shareholders. Taking into account the semi-annual supplemental dividend, Main Street's dividend yield is pushed above 6%. Considering the S&P 500 Index is below 2% right now, this makes Main Street a highly attractive stock for income investors such as retirees.

Final thoughts

Investing in business development companies carries unique risks, and may also have certain tax implications for investors. As a result, investors should carefully consider whether BDCs are a good fit for their portfolios. But for investors that are interested in the BDC asset class, Main Street is one of our top picks due to its successful track record and high dividend yield.

Disclosure: No positions.

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This article first appeared on GuruFocus.