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3 Reasons to Buy Main Street Capital

By Robert Eberhard - Nov 28, 2012 at 9:52AM

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Should you consider adding this sector leader to your portfolio?

If you follow the financial sector as I do, you tend to keep an eye on certain banks and financial companies. Investors scouring the financials for income tend to focus on REITs of various types, especially mega yielding mREITs like Annaly Capital (NLY -1.08%).

But there is another small but growing segment in the financial services industry that merits attention. Business development companies, or BDCs, are publicly traded private equity firms that invest in companies at various stages of development, providing much-needed capital for stakes in the company. Many of the companies in this sector pay high dividends, but one of my particular favorites is Main Street Capital (MAIN 2.20%). What follows is three reasons why I think Main Street Capital would be a great addition to your portfolio.

1. Business model
In a couple of ways, a BDC is very similar to a REIT. They receive special tax treatment as long as they pay out at least 90% of their earnings as dividends. They also tend to benefit from the low interest rate environment that we currently find ourselves in, as they are able to borrow money at low rates and invest in the particular type of company that they choose.

Since I fully believe that the economy will get better before it gets worse, Main Capital should continue to have success as the economy continues to improve. By providing equity capital to "lower middle market companies" -- companies with annual revenues between $10 million and $150 million -- Main Street focuses on businesses with names that you may not recognize, but companies that are nonetheless important in providing economic input and jobs to citizens. In turn, they will provide higher income to Main Street Capital as their performance improves, boosting its performance.

2. Dividend
Better performance can only lead to more income, and in turn, higher dividends for shareholders. Main Street is already unique among similar companies because it pays its dividend monthly as opposed to quarterly. Its dividend has gradually grown since it started paying monthly dividends in September of 2008, helping to push its current yield to around 6%. Combine that with a special dividend of $0.35 per share to be paid out in January, and you'd have a quick boost to your investment, though you only have until January 4th to reap the benefits of the payment.

One great benefit to a monthly dividend is regular monthly income. With the majority of companies paying dividends quarterly, and often in the same quarter as everyone else, it could be difficult to spread your income throughout the year. If you are participating in a dividend reinvestment plan, it also allows for monthly dollar-cost averaging within your investments.

3. Recent stock performance
My colleague John Maxfield points to one problem with BDCs: high dividend payments tend to depress the value of the stock because the companies don't retain earnings and have difficulty appreciating in value. This, however, doesn't appear to be the case for Main Street, at least over the past year, a time frame that has seen its stock performance outperform peers like Apollo Investment (AINV 1.67%) and Prospect Capital (PSEC 1.83%), as well as strong performing Dow stocks like Procter & Gamble (PG -1.84%) and Johnson & Johnson (JNJ -1.15%):

MAIN Chart

MAIN data by YCharts.

Though I must caveat that past performance is not always an indicator of future performance, this strong performance over the past year cannot be ignored. If it is able to continue to perform at even half this rate going forward, it will make a lot of investors happy, including me. It truly is a sector leader and should be considered as an addition to your portfolio.

The Foolish bottom line
The three reasons I've provided above should not be the only reason you purchase Main Street Capital if you decide to do so, but they were enough for me to purchase some shares a few months ago. I encourage you to do your own due diligence into the company and hope that this is a good starting point as you delve deeper into your research.

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Stocks Mentioned

Main Street Capital Corporation Stock Quote
Main Street Capital Corporation
MAIN
$36.91 (2.20%) $0.79
Annaly Capital Management, Inc. Stock Quote
Annaly Capital Management, Inc.
NLY
$6.38 (-1.08%) $0.07
The Procter & Gamble Company Stock Quote
The Procter & Gamble Company
PG
$144.92 (-1.84%) $-2.71
Apollo Investment Corporation Stock Quote
Apollo Investment Corporation
AINV
$12.15 (1.67%) $0.20
Johnson & Johnson Stock Quote
Johnson & Johnson
JNJ
$179.32 (-1.15%) $-2.08
Prospect Capital Corporation Stock Quote
Prospect Capital Corporation
PSEC
$7.50 (1.83%) $0.14

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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