Despite the S&P 500 falling 3.4% year to date, the index is still priced at a valuation near its all-time high. This has pushed the S&P 500’s dividend yield down to 1.27%, which isn’t far off its all-time low of 1.1% set at the peak of the dot-com bubble 20 years ago.
This has made it more difficult for income investors to find high dividends that aren’t yield traps. But the good news is that there are still high-yield dividend stocks out there that yield-hungry investors can lean on. I believe one of those reliable high-yield dividend stocks is the business development company (BDC) Main Street Capital (NYSE:MAIN). Let’s take a look at why.
A diversified and well-run BDC
To better understand Main Street Capital’s business model, it might be helpful to start by explaining the function of a business development company. BDCs are investment companies that exist to meet the financing needs of smaller companies. Smaller companies often get locked out of issuing bonds or obtaining loans through financial institutions. So, they either issue a slice of ownership (i.e., equity) in their business, or they pay higher-than-average interest rates on loans to BDCs willing to provide them with capital.
Main Street Capital mostly invests in the lower middle market. These are companies that typically have annual revenue of between $10 million and $150 million and annual earnings before interest, taxes, depreciation, and amortization (EBITDA) between $3 million and $20 million.
Because there are nearly 200,000 lower middle market (LMM) businesses in the U.S., there are plenty of attractive investment opportunities for Main Street Capital for both equity and debt. First, Main Street Capital usually invests in businesses at EBITDA multiples between just 4.5 and 6.5. This is due to the market being underserved by BDCs and there being fewer sources of capital for LMM businesses. Second, Main Street Capital usually invests in debt at interest rates between 8% and 12%, with 67% of the company’s debt investments bearing interest at floating rates. This means that the interest rates paid to Main Street Capital can go higher when rate hikes occur, which translates into higher distributable net investment income for the company because 87% of its debt obligations have fixed interest rates. This makes Main Street Capital a great way to play the news that the Federal Reserve will likely be hiking interest rates three times this year to combat inflation.
Main Street Capital’s $3.9 billion equity and debt investment portfolio is diversified into 177 companies throughout a variety of industries, including construction and engineering, software, and healthcare providers and services. And the largest individual company in the portfolio made up 3.2% of Main Street Capital’s total investment income.
Main Street Capital’s solid business model and diversification enabled the company to bounce back quickly from the COVID-19 pandemic. For instance, Main Street Capital’s $2.67 in distributable net investment income per share over the past four quarters is slightly higher than the pre-COVID figure of $2.66 for 2019.
The payout is safe for its industry
Main Street Capital’s fundamentals appear to be heading in the right direction as the economic reopening progresses due to society better learning how to live with COVID-19. But how can investors be sure that Main Street Capital’s market-beating 5.8% dividend yield is sustainable?
Over the last four quarters, Main Street Capital has paid $2.46 per share in dividends. While this equates to a 92.1% payout ratio against the $2.67 in distributable net investment income per share in the previous four quarters, this is reasonable for its industry. That’s because for BDCs to maintain their status as a regulated investment company and avoid paying corporate income taxes, they must distribute at least 90% of their taxable income to shareholders.
As a testament to its quality, Main Street Capital has never reduced its monthly dividend paid to shareholders since going public in 2007. Since that includes the Great Recession and the COVID-19 pandemic, it’s a rather impressive track record. In fact, Main Street Capital’s dividend has been raised 95% from the $0.33 per share paid in the fourth quarter of 2007 to the $0.645 per share that will be paid in the first quarter of this year.
A stock that income investors will love
Main Street Capital boasts a high dividend yield that can turbocharge an income portfolio. But it’s just as important to note that this passive income appears to be dependable based on the stock’s improving fundamentals, manageable payout ratio, and strong track record. Income investors looking for a steady monthly dividend payer would do well to consider buying Main Street Capital at its current $44 share price and on any pullbacks going forward.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.