Main Street Capital stock: beating BDCs and S&P 500, but there’s a catch

Main Street Capital (NYSE: MAIN) stock price is firing on all cylinders as it continues to outperform the S&P 500 index. 

Its stock has risen by 15.7% this year while the S&P 500 index is up by over 17%. With dividends included, it has jumped by 20.5%. 

Main Street Capital shares have jumped by more than 387% from the pandemic low of $10 in March while the S&P 500 index has risen by 173% in the same period. 

The company has also beaten other popular Business Development Capital (BDCs) like Golub, Prospect, and Owl Rock Capital Corporation. 

A high-quality BDC

The private credit business has been a big theme in the financial services industry in the past few years. 

The sector gained momentum after the Global Financial Crisis (GFC), which pushed more big banks to slow their lending to small and midsize businesses. 

Main Street Capital and other BDCs have stepped in the gap and are providing substantial funding to these companies. In most cases, MAIN invests in companies that have revenues of between $10 million and $150 million. 

It also typically invests in loans that have a term of between five and seven years. Most of its clients are required to pay their interest monthly or quarterly, depending on their agreement. The average interest rate is usually between 10% and 14% annually, higher than what government bonds pay.

Therefore, the Main Street Capital stock has done well as it benefited from high interest rates since its loans are often on variable terms. This means that its clients adjust their payments based on the Secured Overnight Financing Rate (SOFR).

As a BDC, MAIN is different from other companies. For one, like REITs, it is required to distribute 90% of its taxable income to shareholders through dividends. It also does not pay a corporate income tax, which allows more money to flow to investors.

As a result, Main Street Capital has historically paid high dividends to investors. It has grown its dividends in the last three years and has a forward yield of 8.2%, which is covered well.

Read more: BDC vs REIT vs MLP: Best SWAN stocks to buy as rates rise?

Main Street Capital earnings and valuation

Main Street Capital has done well in the past few years, helped by high interest rates. Its revenue rose from $222 million in 2020 to over $500 million in 2023. In the same period, its annual profit rose from just $29 million to over $428 million. 

The most recent financial results showed that Main Street Capital’s net investment income rose to $132 million, up from $127 million in the same period in 2023. Excluding costs, the net investment income rose to $87 million.

Nonetheless, there was a big issue in its financial results: rise of non-accruals, which accounted for 1.2% of the total investment portfolio at fair value. In its statement, the management cited companies in the consumer segment of the market. 

This weakness could continue as evidenced by earnings by the weak earnings of consumer names like Home Depot and PepsiCo.

The other big issue to remember is that Main Street is not a cheap company. When using multiples like price-to-earnings, we see that the company looks cheap as it has trailing and forward multiples of 9.25 and 10.8, respectively.

However, for a company like Main Street, the best approach to view its valuation is through the price-to-book metric. Its trailing twelve-month P/B multiple is 1.66, higher than the sector median of 1.27. Its forward multiple is 1.65, also higher than the sector median of 1.22.

The trailing multiple is also higher than the five-year average of 1.59. Therefore, this valuation means that the company trades at a 66% premium to its net assets, which is not cheap.

In contrast, Golub Capital has a trailing P/B ratio of 0.97 while Ares Capital, another quality BDC, trades at a multiple of 1.06. 

Therefore, these numbers mean that Main Street Capital is trading at a big premium to its book value and its peer companies. 

Investing in overvalued companies is not always a bad thing, as we have seen with firms like Apple and Nvidia. However, there is a risk that its future performance will not be strong as interest rates start coming down.

Main Street Capital stock analysis

The daily chart shows that the MAIN share price has done well in the past few months. Recently, however, it has faced some turbulence as it dropped from the year-to-date high of $52.13 in July to $49. 

The stock has moved slightly above the 50-day moving average, meaning that bulls have some control. Therefore, the outlook for the Main Street share price is bullish, with the next point to watch being the year-to-date high of $52.13. A break above that level will point to more upside since it will invalidate the double-top pattern.