When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") above 18x, you may consider Capital Southwest Corporation (NASDAQ:CSWC) as an attractive investment with its 14x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Capital Southwest certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

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How Is Capital Southwest's Growth Trending?

Capital Southwest's P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 86% last year. However, this wasn't enough as the latest three year period has seen a very unpleasant 32% drop in EPS in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 4.9% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 10% each year, which is noticeably more attractive.

With this information, we can see why Capital Southwest is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Bottom Line On Capital Southwest's P/E

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Capital Southwest maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Plus, you should also learn about these 4 warning signs we've spotted with Capital Southwest (including 3 which shouldn't be ignored).

If these risks are making you reconsider your opinion on Capital Southwest, explore our interactive list of high quality stocks to get an idea of what else is out there.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com