Even during a down period for the markets, Capital Southwest has gone against the grain, climbing to $22.90. Its shares have yielded a 10.9% return over the last six months, beating the S&P 500 by 13%. This was partly due to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is there a buying opportunity in Capital Southwest, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Is Capital Southwest Not Exciting?
We’re glad investors have benefited from the price increase, but we're cautious about Capital Southwest. Here are two reasons why CSWC doesn't excite us and a stock we'd rather own.
1. EPS Barely Growing
We track the long-term change in earnings per share (EPS) because it highlights whether a company’s growth is profitable.
Capital Southwest’s EPS grew at an unimpressive 7.2% compounded annual growth rate over the last five years, lower than its 28% annualized revenue growth. This tells us the company became less profitable on a per-share basis as it expanded.
2. High Debt Levels Increase Risk
Capital Southwest reported $42.56 million of cash and $1.39 billion of debt on its balance sheet in the most recent quarter.
As investors in high-quality companies, we primarily focus on whether a company’s profits can support its debt.
With $143.1 million of EBITDA over the last 12 months, we view Capital Southwest’s 9.4× net-debt-to-EBITDA ratio as inadequate. The company’s lacking profits relative to its borrowings give it little breathing room, raising red flags.
Final Judgment
Capital Southwest isn’t a terrible business, but it isn’t one of our picks. With its shares outperforming the market lately, the stock trades at 10× forward P/E (or $22.90 per share). While this valuation is optically cheap, the potential downside is big given its shaky fundamentals. We're pretty confident there are more exciting stocks to buy at the moment. We’d recommend looking at the Amazon and PayPal of Latin America.
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