When you're retired or are approaching retirement, having significant sources of monthly passive income can provide you with some extra peace of mind. There are dozens of companies that pay their dividends on a monthly basis. But they are not all created equal: Some dividends are safer than others.
Business development company (BDC) Main Street Capital (MAIN 1.13%) is a monthly dividend payer with a payout that's arguably safe. Here are three reasons the stock is a buy for investors seeking stable sources of passive income.
1. The business model is lucrative
When the BDC business model is executed properly, it can be tremendously profitable. These companies hook smaller, less-established businesses up with the capital they need to finance expansion projects. In exchange, BDCs receive either an ownership position in the business or a debt stake yielding an above-average interest rate.
With nearly 30 years in operation, Main Street Capital is one of the most well-recognized companies in the BDC universe. It focuses on investing in lower-middle-market (LMM) businesses, which it defines as those with annual revenue of between $10 million and $150 million, and earnings before interest, taxes, depreciation, and amortization (EBITDA) of $3 million to $20 million.
The BDC manages $4.8 billion of its own funds and serves as an investment advisor to another $1.6 billion in capital for third parties. As you'd expect for a BDC of its size, Main Street Capital's holdings are quite diversified: As of Dec. 31, it had investments in 194 companies across industries including internet software and services, machinery, and construction and engineering. That's just a tiny fraction of its total addressable market: There are more than 195,000 businesses in the LMM universe.
And unlike most businesses, Main Street Capital benefits from a high-interest-rate environment. That's because 70% of the BDC's debt outstanding used to fund its investments is at fixed interest rates, while 73% of its debt investments bear interest at floating rates that move with rising and falling benchmark rates. Simply put, the higher interest rates go, the more of a spread the company builds between its own debt and its debt investments.
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2. A business that rewards its shareholders
BDCs must meet certain requirements to keep their special status and avoid having to pay taxes at the corporate level. One of these is that they must distribute at least 90% of their taxable income to shareholders annually in the form of dividends. That explains why the stock's yield is a whopping 6.9% (excluding special dividends), which is about quadruple the S&P 500 index's current 1.7% yield.
In 2022, Main Street Capital's dividend payout ratio came in at a sustainable 85%. To be clear, this payout ratio is based on distributable net investment income (DNII), not taxable income. This is how a BDC can have a DNII payout ratio lower than 90% and still maintain its special tax status.
In its nearly 16 years as a publicly traded company, Main Street Capital's regular monthly dividends per share have soared by 105%, from $0.33 in Q4 2007 to $0.675 in declared dividends for Q2 2023. With its modest payout ratio and gradually climbing DNII per share, there is reason to believe slow and steady dividend growth can continue in the years ahead.
3. Main Street Capital isn't cheap, and it shouldn't be
Main Street Capital rarely trades at a bargain-bin valuation. And since its fundamentals remain about as strong as they have been at any point in its time as a public company, it shouldn't be deeply undervalued.
This is why even though the stock's price-to-tangible-book ratio of nearly 1.5 is above the 10-year median of 1.4, I believe the stock is a buy for yield-focused investors.
