Home Run #6

I'm happy to report my sixth home run stock! Recall that I call a stock a home run stock when it passes the 100% profit mark taking total return into account.

While my goal with DivGro is to build a growing dividend income stream, its fun to see some stocks perform well enough to become home run stocks. These stocks present dividend growth investors with some tricky questions. Are the stocks suitable for further investment, or are they now overvalued? Is it appropriate to increase the average cost basis of a position by buying more shares?

When I look at my portfolio, I see many stocks that have gone up significantly after I bought shares. Buying more shares would increase my average cost basis, something I've tried to avoid so far. But is increasing average cost basis necessarily a bad thing?

My sixth home run stock is Main Street Capital Corporation (MAIN), a principal investment firm that provides long-term debt and equity capital to lower middle market companies and debt capital to middle market companies. Portfolio investments are typically made to support management buyouts, recapitalization, growth financing, refinancing and acquisitions of companies that operate in diverse industry sectors.

MAIN is one of the stocks in my portfolio that I've added shares to even at higher prices. Below is a chart showing the 5 occasions I bought shares of MAIN:

My average cost basis is $21.71 and average yield on cost (YoC) is 9.95%. With MAIN trading at $34.55 per share, the stock yields 6.42%.

MAIN has not yet reached doubler status as far as its stock price goes. However, I've collected more than $2,000 in dividends from MAIN alone, for a payback of 42%! Adding dividends received to unrealized capital gain totals $5,056, or 101% of my initial investment.

Returning to the questions in the introduction, should I buy more shares of MAIN even if doing so increases my average cost basis?

My fair value estimate is $35, so MAIN is trading at about fair value. Although I prefer a 10% margin of safety, I would be OK buying shares at this level. If I do so, though, my average cost basis will increase.

I've seen comments by a Seeking Alpha contributor, Chowder, in which he advocates buying shares of a great dividend growth stock that continues to experience higher earnings expectations, even if the stock is trading above fair value. He calls the strategy dollar-cost averaging up.

I think I understand why Chowder follows this strategy. He argues that the fair value of a company will increase with higher earnings expectations and that the stock price will follow. The strong often get stronger.

Looking at MAIN's performance and how I added to my position over the time, perhaps the idea of not buying shares because you want to avoid increasing your average cost basis is silly. I'll be revisiting this strategy in the coming weeks.

Updates

While MAIN is my sixth home run stock, I only have 4 home run stocks in my portfolio right now. Here are updates of the other home run stocks:

• My first home run stock, General Dynamics Corporation (GD), has returned 141% at an annualized rate of 40%. My fair value estimate is $155, so the stock is trading at fair value.
• My fourth home run stock is Altria Group Inc (MO). The stock has returned 105% at an annualized rate of 41%. My fair value estimate is $62, so the stock is trading at a premium of about 8% to fair value.
• While I still count Reynolds American, Inc (RAI) as a home run stock, it no longer shows a total return above 100%. The reason is I bought more shares of RAI to round out my position to 200 shares, increasing my average cost basis. The stock has returned 89% at an annualized rate of 40%.

I've sold the other two home run stocks, Nippon Telegraph and Telephone Corp (NTT) and Digital Realty Trust, Inc (DLR), mainly to prepare DivGro for options trading.

Do you have home run stocks in your portfolio? Please let me know in the comments section...