BDCs are often an income-investor favorite (thanks to their big growing dividends). And among BDCs, Main Street Capital (MAIN) has consistently been a top performer. However, investors frequently misunderstand Main Street’s fundamentals (i.e. they incorrectly believe price-to-book is too high and they forget to properly consider special dividends when considering the yield). In this report, we share data on 40+ big-yield BDCs, considering current price-to-book values (versus history), current market conditions (including how much credit spread risk is priced in) and the breakdown of historical returns (in terms of price gains versus dividend income). We conclude with out strong opinion about investing in BDCs in general and Main Street Capital in particular.
40 Big-Yield BDCs Compared
For starters, the following table is sorted by market cap (with Main Street Capital as 5th largest). The table also shows current dividend yield, price relative to 52-week range, Wall Steet analyst ratings, price-to-book value (relative to the 5 year range) and more.
You likely recognize at least a few of your favorite BDCs in the above table, and we’ll refer to this data throughout this report. You can also see (in the chart below), that several popular BDCs are up this year, but have pulled back over the last month.
Why BDCs are Special:
No Corporate Taxation: For starters, BDCs don’t pay tax at the corporate level as long as they pay out their income as dividends. This gives BCDs a big advantage over other companies, and this advantage was created by an act of Congress in the 1980’s because they wanted to make it easier for small businesses to thrive (BDCs provide financing and capital to small (middle market) companies).
Less Regulation: Another reason BDCs are special is because they are allowed to take on “risks” that traditional banks are not allowed to due to stricter regulatory rules (and reserve requirements) following the great financial crisis. Generally speaking, this enables BDCs to invest in attractive opportunities that traditional banks are not able to. This is amazing because (as you can see in our earlier table) some BDCs have actually outperfomed the market (e.g. the S&P 500 over the last 5 and 10 years) which is a lot more than you can say for other big-yield investment categories (such as bond closed-end funds and many REITs). It’s doubly amazing because the S&P 500 includes many top growers like the “Magnificent 7” megacaps (which have dominated market performance).
How Much Risk is Priced In:
To get an idea of how much current market risk is priced into BDCs we can look to credit spreads. Credit spreads are the difference in yield between low risk loans/bonds (such as US treasuries) and higher risk loans/bonds (such “risker” debt and BDCs).
As you can see in the chart above (we’re using VanEck’s BDC ETF (BIZD) as a proxy), BDC prices tend to rise and fall with credit spreads, and the market is currently NOT pricing in too much risk (which can be an indication of subdued price returns going forward). Said differently, now may not be the best time to invest in BDCs if you are looking for strong price gains, however most people invest in BDCs for the big dividend income (as we describe in the next section). And to support this point, you’ll notice in our earlier chart that a lot of BDCs do NOT currently trade at big discounts to book value (instead they trade at small premiums versus history).
Historical Price Gains Verus Dividend Income
Sticking with BIZD as an industry proxy, you can see that historically most BDC returns have come from dividends NOT price gains (i.e. BIZD’s price has been relatively flat over time, which means those big longer-term total returns have come from the big dividend payments—which is exactly what a lot of investors are looking for).
Main Street Capital Is Special:
Main Street Capital is a popular BDC, and it is special for a few reasons.
Internally Managed: Main Street is internally managed (a lot of people like this because it has the potential to reduce expenses/fees and reduce conflicts of interest between shareholders and management).
Consistent Premium to Book: A lot of investors are afraid to invest in Main Street because it consistently trades at such a high price relative to book value (currently ~1.7x) as compared to other BDCs (see our earlier table). However, as you can see in the chart below, Main Street also has a strong history of delivering better price returns than a lot of BDCs.
So whereas Main Street’s dividend yield is low by BDC standards, its price returns are high, and its total returns have been steallar (as you can see in the chart above).
Tax Considerations: And even though Main Street may look particularly expensive on a price-to-book value basis (as compared to other BDCs), it’s not. Main Street consistently trades at a bigger premium because it consistently generates higher price returns. It also has a slightly lower (conservative) regular dividend yield, but that is supplemented with fairly regular speical dividends too (that make the actual dividend yield even higher—more on this later).
And from a tax standpoint, Main Street’s lower yield can be helpful if you own it in a taxable account because BDC dividends are generally NOT qualified (meaning they don’t qualify for the lower dividend tax rate). Specifically, if you own Main Street in a taxable account it may be to your advantage to get more of your return from price appreciaton (because you control when the capital gains are taxed (i.e. when you sell) and those capital gains may be taxed at a lower rate (depending on your tax bracket). For reference, in 2023, approximately 8% of MAIN’s dividend was taxed as qualified and approximately 92% was taxed as ordinary income.
Growing Monthly Dividend: As you can see in the gray bars below, Main Street also has a very stong history of growing the monthly dividend (to keep pace with the price gains over time). Only a handful of BDCs pay monthly (most pay dividends quarterly).
Special Dividends: Further still, Main Street frequently pays additonal “special dividends” that make the income it provides even more attractive than a lot of investors realize (i.e. many sources that report BDC dividend yields don’t recognize the special dividends too—which make Main Street’s yield even more compelling versus peers).
High-Quality Diversified Portfolio:
Main Street’s investment portfolio is diversified across transactions types and geography.
Plus, the aggregate portfolio has an effective yield of 12.8% (enough to cover the dividend, including special dividends, after operating expenses) and only 0.5% of the total portfolio is in non-accrual status (i.e. not properly paying their loans per agreed upon terms). Main Street is currently invested in (i.e. providing capital to) 191 comapnies (with an average investment size of $19.2 million), and the largest is only 3.6% of the total portfolio (most are less than 1%) thereby reducing risks through diversification.
Conclusion:
Overall, if you are are income-focused investor, BDCs remain attractive. They are NOT poised to deliever outsized price gains right now (they rarely ever are), but they are poised to keep paying big steady dividend income (which is exactly what a lot of income-focused investors want). And despite what appears to be a high price-to-book value (it’s not, when you consider price gains) and a low dividend yield (it’s not when you consider special dividends), Main Street Capital is particular attractive and worth considering if you are a disciplined, long-term, income-focused investor.