– Tim Plaehn, Editor, The Dividend Hunter
Once when asked about the right time to sell stocks renowned investor Warren Buffett said,“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for 10 years.” By that of course he means he’s not looking for gains today, tomorrow, next month, next year or even next decade.
There are certain stocks that once you put them in your portfolio you’ll never want to sell them. In Buffett’s case the most famous example of this is The Coca-Cola Company.
Buffett began buying Coca-Cola stock in 1988 and by 1995 he had about 100,000 shares. Today he has over 400 million shares.
Along the way he’s collected over 110 dividend payments from Coca-Cola. No one will ever say that Coca-Cola is a high-yield stock but combining the company’s consistency in paying dividends and Buffett’s foresight to hold the stock for nearly 30 years now has enriched him almost beyond imagination.
The next dividend payment from Coca-Cola will be for 41 cents. Multiply that times 400 million and then four times a year and then multiple years and you start to see the power of holding a stock forever.
Forever Stock #1: Main Street Capital Corp. (MAIN)
12 Dividends/Year
with a 6.84% yield.
Yielding 6.84%, and having a twelve-year track record of superior dividend growth, this may just be the best income stock that exists.
I regularly review a large number of high yield stocks. I try to dig out the details that separate a high-quality company from one that has the potential to truly whack investor wealth. I often talk about how tremendous value can be found in the dark corners of the stock market, where the investing public doesn’t understand how these undiscovered nuggets of dividend paying companies operate. But sometimes I realize I need to go back and discuss a stock that should be a core holding for almost every stock market investor.
We can all learn some lessons from an overview of howMain Street Capital Corporation (MAIN) operates and pays investors.
This business development company (BDC) has been a tremendous stock for income focused investors. In fact, on May 2, 2023 MAIN raised the monthly dividend to $0.23 per share, a 2.2% increase over the second quarter of 2023 and a 7.0% increase from the regular monthly dividends paid in the third quarter of 2022.
In addition to the regular monthly dividends for the third quarter of 2023, the Board of Directors declared a supplemental cash dividend of $0.225 per share payable in June 2023.
Since my first recommendation, the monthly dividend paid by MAIN has been increased 12 times, and the company has resumed paying two special dividends per year.
Prior to the market crash in spring 2020 MAIN had been hinting at discontinuing the special dividend payouts and just increasing the regular monthly dividends by the amount they would have paid in the special dividends.
Shortly after the crash MAIN suspended the special dividend.
But as you can see, MAIN is a powerful dividend income stock, and it is time to re-review this best-in-class business development company.
It is also one of the most popular holdings among Dividend Hunter subscribers.
Legally, a BDC is a closed-end investment company, like closed-end mutual funds (CEF). The difference is that a CEF owns stock shares and bonds, while a BDC makes direct investments into its client companies.
A BDC will have up to hundreds of outstanding investments to spread the risk across many small companies. The client companies of a BDC will be corporations that are too small or too new to be able to issue stock or bonds into the publicly traded markets.
As a risk control factor, BDCs are limited to debt of no more than two times its equity.
This means that if a BDC has $500 million of equity raised from selling shares, it can borrow $1 billion. The company can then make $1.5 billion of loans or equity investments.
Main Street Capital Corp. is really quite different from the rest of the BDC crowd. Since its 2007 IPO, MAIN has tripled the total return average of its BDC peers.
Houston-based Main Street Capital has helped over 200 private companies grow or transition by providing flexible private equity and debt capital solutions.
The company provides “one-stop” capital solutions (private debt and private equity capital) to lower middle market companies and debt capital to middle market companies.
Main Street’s lower middle market (LMM) companies generally have annual revenues between $10 million and $150 million. While Main Street’s middle market debt investments are made in businesses that are generally larger in size.
The company’s current investment portfolio consists of 51% LMM, 36% Private Loan and 7% Middle Market companies and 6% other investments.
On December 31, 2021, Main Street Capital had 30 middle market clients with an average loan amount of $13 million. The loans total over $306 million or about 7% of MAIN’s total portfolio.
Middle market loans are floating rate and match with MAIN’s floating rate debt facility. The average 11.8% yield on this group of loans is 4.75% higher than Main Street’s debt used to fund the loans to clients. The 4.5% interest margin is almost pure cash flow that can be used to help pay dividends on MAIN’s stock shares.
The largest portion of the portfolio is lower middle market (LMM), where the company takes equity stakes along with providing debt financing. Equity provides a significant boost to the total returns generated. Lower middle market companies are smaller than the typical BDC client and have annual revenues between $10 and $150 million.
There are over 175,000 companies in this revenue bracket in the U.S., and MAIN has 79 lower middle market clients with loans and equity investments worth $2.1 billion. The loans to the companies in this part of the portfolio have an average yield of 12.6%.
The equity position gives an average 41% ownership of the client companies. The equity stakes are what have allowed MAIN’s net asset value (NAV) to increase from $12.85 in 2007 to $27.23 on March 31, 2023 – 112% growth.
The equity investments are what set MAIN apart from most other BDCs. The rules under which these companies operate prevent them from setting aside loan loss reserves. Because a BDC makes higher risk loans, there will be loan losses. These losses have a direct negative effect on a BDC’s book or net asset value. That is why most BDCs struggle to maintain their book values compared to the growing value built by Main Street Capital.
In recent years, Main Street has been growing what it calls its PrivateLoan Portfolio. These are loans originated through strategic relationships with other investment funds on a collaborative basis and are often referred to in the debt markets as “club deals”.
The private loan portfolio makes up 36% (86 loans for $1.5 billion) of the overall MAIN portfolio and carries an average yield of 12.4%. The loans have floating interest rates and benefit from lower overhead costs.
This three-tier investment portfolio is what sets MAIN apart from the rest of the BDC crowd, and what makes it an income stock for all seasons.
The lower middle market client, middle market client, and private loans mix provides a combination of net interest income to support MAIN’s very excellent history of dividend payments. Plus, MAIN holds an industry leading position in cost efficiency, with an Operating Expense to Assets Ratio of 1.4%.
The result has been a BDC that has generated both regular dividend growth for investors and special dividends to pay out capital gains. As an additional bonus, MAIN pays monthly dividends, smoothing out the cash flow into your brokerage account. MAIN should be a core holding for any income focused investor.
These facts add up to a very high-quality income investment with a 6.84% yield on the monthly dividends alone. The bonus dividends are just that, an added bonus on top of a great yield. The regular dividend increases will result in a low-teens yield on cost in just a few years. I know of no other stock that can be counted on to pay you 12-plus dividends per yearandprovide a growing cash income stream. If you do not own any MAIN shares, go buy some.
Main Street Capital teaches us another lesson about income stock investing. You can see I have laid out the case that MAIN is one of the most consistent dividend paying and dividend growing stocks you can buy. Yet over the last year alone there is a 41% difference between the 52-week low and the 52-week high share prices. Stability of business operations and dividend payments does not lead to stability in share prices.
As income-focused investors, we need to always be aware that those big share price swings that occur regularly in the market do not indicate the quality of the income stream we want to earn from an income-focused portfolio. We buy for the income, andshare price swings are only viewed as buying opportunitieswhen share prices experience a decline.
Finding companies that regularly increase their dividendsis the strategy that I use myself to produce superior results, no matter if the market moves up or down in the shorter term. The combination of a high yield and consistent dividend growth in stocks is what has given me the most consistent gains out of any strategy that I have tried.
Forever Stock #2: Realty Income Corp
4.4% Yield with Dividends EveryMonth
In the entire stock universe, there is a small sub-sector that has been consistently handing out double digit returns to investors regardless of market conditions.
I want to spend some time here discussing a different way to analyze stock investments and an investment strategy that does not involve trying to find stocks that will go up more in value than the market averages.
While I find it very difficult to find stocks that will consistently generate above average capital gains, I find it an easier task to build a portfolio of stocks that will provide me with a cash flowpay raiseevery quarter.
The strategy I use is to focus my search on finding higher yield stocks with histories and future potential for regular and growing dividend payments. Most stock market analysts, advisors, and investors themselves focus on new products, revenues, earnings per share, and share prices and what effects the latest economic news will have on the individual company metrics. The result is a blizzard of information that is often contradictory and share prices that end up moving up and down together, no matter how good the prospects of an individual company might be.
A dividend-focused approach to stock market investing takes out the part where investors have to try to figure out whether share prices are going to go up or down, and which stocks will do better or be able to buck the trend if the market is falling in general. With a dividend-centric investing strategy, you work to find stocks with attractive yields and growing dividends. These stocks will produce a growing cash flow stream and also, in the longer term, generate high share prices. Let’s look at one. more example.
Realty Income Corp (O)is the poster child stock for this cash flow focused investing strategy.
This conservatively managed REIT has increased its dividend rate almost 100 times in the last 25 years, with zero dividend reductions. There have been 90 consecutive quarterly increases or six straight years of quarter over quarter dividend growth. During the last decade, the yield on O has ranged from about 4.1% to around 7.5%. The dividend growth rate has averaged 4.5% per year. The regular dividend payments with steady growth in those dividends have produced an average total return of over 14% per year from Realty Income.
And as a bonus,the company pays monthly dividends.
All the factors above make O a great stock to add to any dividend focused portfolio. But as with any investment strategy, dividend investing requires significant research to continuously evaluate potential new stocks to buy.
To be a successful income investor, you need to dig out those companies and stocks with above average yields and histories of steady dividend increases. Study the business operations of each company to understand how the cash flow is earned to pay those growing dividends and make your own evaluation whether the business will continue to support a growing dividend stream. This is a crucial step because many high yield companies do not provide the visibility for future cash flows that will let you sleep at night.
Then, build a diversified portfolio of dividend paying stocks. You will want to own companies from different sectors including finance and equity REITs like O above and business development companies (BDCs) like MAIN. These are the sectors that allow a company to generate steady and growing cash flows to support the dividend stream you want to earn.
The goal is to buy these stocks for the long term, and you will own many of them for years collecting dividends along the way, just as Buffett has done with Coca-Cola.
However, you must be ready to drop those companies that fail to live up to your cash flow forecasts and add new candidates that offer better combinations of yield and dividend growth potential. If you are investing for the growth of an investment account, use the dividend earnings to buy new holdings or to pick up more shares of companies that have fallen out of favor with the market.
With this type of stock market portfolio, you should see your dividend earnings grow every single quarter no matter the market conditions. That’s a great feeling and one that can help you sleep at night.
If you’re serious about a retirement with less financial worries, I’d love to share with you one stock that can support an entire retirement plan. That’s right. Just one stock for the rest of your life. If you act now, I can even share this plan with you completely risk-free for one year.
Limited Time Offer: The #1 Stock for Retirement
