Here's How Main Street Capital Beats The Market From Here

Main Street Capital (NYSE: MAIN) has been a market-beating investment since its 2008 IPO. The business development company (BDC) has delivered a 17.2% annualized total return, meaningfully outpacing the S&P 500's 8.4% annualized return. The investment firm has delivered those strong returns by growing its income and dividend payments.

Here's a look at what the BDC stock needs to do to beat the market from here.

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The secret to its success

Main Street Capital is a BDC that provides capital (debt and equity) to private companies. It will make debt and equity investments in lower-middle-market (LMM) companies (those with annual revenue between $10 million and $150 million). Secured debt investments generate interest income, while equity investments provide dividend income and potential capital appreciation. Main Street Capital also makes debt investments in companies with annual revenue between $25 million and $500 million, owned or in the process of being acquired by a private equity fund. Additionally, the company generates net investment income and management fees from its asset management business.

The company has an excellent track record of underwriting investments. That has enabled it to generate predictable interest income while preserving the value of its assets. This interest income supports the company's dividend payments. Additionally, Main Street Capital often receives equity in LMM companies as part of its investments. This equity can provide dividend income and potential capital appreciation.

How Main Street Capital can continue beating the market

Main Street Capital's strategy for beating the market in the future is simple. It just needs to keep doing what it's doing. The BDC needs to maintain its very conservative underwriting approach for new investments. That includes staying diversified (its largest investment in a single portfolio company represents 4.8% of its investment income). Ideally, this percentage should fall as it grows its portfolio (most investments in individual portfolio companies represent less than 1% of its income). Continuing to build a more diversified portfolio helps lessen the risk of a single investment sinking the value of its stock.

Additionally, the company needs to continue maintaining a conservative financial profile. It has a low payout ratio for its regular monthly dividend (1.39 times) and a low leverage ratio (0.73 times net debt to net asset value ratio). Maintaining its financial flexibility should enable it to continue growing its monthly dividend even during more turbulent economic times.

Finally, Main Street Capital needs to continue gaining meaningful equity participation in LMM investments. These equity investments generate dividend income, help grow the net asset value of its shares, and provide it with the opportunity to realize gains upon the sale of one of its portfolio companies. The company can reinvest gains into new investments, compounding returns for investors. Since its IPO, Main Street Capital has grown its NAV by 155%, mainly driven by its equity investments.

Main Street Capital can continue to beat the market

Main Street Capital has a long record of delivering market-beating total returns. The BDC can continue beating the market by sticking with its winning strategy, which includes making equity investments in its portfolio companies. The company's market-beating potential makes it a top monthly dividend stock to buy.

Matt DiLallo has positions in Main Street Capital. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.