Ultra-high-yield dividend stocks can be excellent sources of passive income for individuals seeking financial independence. But this comes with a caveat: Not all ultra-high yields are safe.
But the business development company (BDC), Main Street Capital (MAIN 0.23%) appears to pay a safe, monthly dividend to its shareholders. Let's dig into whether the stock is a good fit for your portfolio.
A fundamentally sound BDC
For those who are unfamiliar with the function of a BDC, these companies provide capital to smaller businesses and/or less proven businesses to fund future growth opportunities. In return for these funds, the businesses issue equity stakes to the BDCs and/or debt stakes bearing high interest rates.
Main Street Capital manages $4.5 billion of its own assets and serves as an investment advisor to external parties on another $1.5 billion in assets. The company specializes in assisting lower-middle market (LMM) clients. Businesses that generate annual revenue between $10 million and $150 million and earnings before interest, taxes, depreciation, and amortization (EBITDA) ranging from $3 million to $20 million fit into this category.
As large as Main Street Capital has grown since its founding in the mid-1990s, there's reason to believe that there is much more upside for the company to grow in the future. This is because there are nearly 200,000 businesses that fit into the LMM group. Right now, the diversified BDC has debt and equity investments in just 195 total businesses spread across dozens of industries.
In the near term, Main Street Capital should also benefit from the current environment of high interest rates. The vast majority of the company's outstanding debt (73%) is at fixed interest rates. With 76% of Main Street Capital's debt investments bearing interest at floating rates, this means the higher interest rates go, the greater a spread the company earns on its investments.
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Slow and steady dividend growth wins the race
As a requirement of maintaining its BDC status and enjoying the perks of paying no taxes at the corporate level, Main Street Capital must pay at least 90% of its profits to shareholders via dividends. This is why the company sports a massive 6.9% dividend yield (counting only regular dividends), which is more than four times the S&P 500 index's average 1.6% yield.
And since Main Street Capital's overall dividend payout ratio (regular dividends and special dividends) clocked in at under 92% over the past four quarters, the dividend is well-covered. This should allow the company to build on its reputation for dividend growth moving forward. Putting things into perspective, Main Street Capital's regular dividends per share more than doubled from $0.33 in Q4 2007 to $0.675 in Q1 2023.
The stock is a decent value
Main Street Capital is a top-notch BDC. Yet the valuation doesn't appear to be particularly expensive at the current $40 share price.
Main Street Capital's price-to-book-value ratio of 1.5 is just below its 10-year median of 1.6. For a company whose fundamentals are as strong now as they have been at any point in the last decade, this is a reasonable valuation. That's why I believe shares of Main Street Capital are a buy for investors seeking robust starting passive income and modest capital appreciation.
