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Capital Southwest: Price Dislocation Spells Opportunity

Dec. 02, 2022 7:30 AM ETCapital Southwest (CSWC)67 Comments


  • CSWC is a well-run BDC with a highly fragmented and less competitive lower middle market focus.
  • It continues to demonstrate improving operating leverage and is growing its dividend.
  • It's currently attractively valued and trading at a discount compared to its internally-managed peers.
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Andrii Yalanskyi

Having read many reader comments on BDCs, I get the sense that Price to NAV is an important measure of valuation for this segment. While I believe this is a relevant metric for externally-managed BDCs, well-run internally managed BDCs are simply

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This article was written by

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I am Gen Alpha. I have more than 14 years of investment experience, and an MBA in Finance. I focus on stocks that are more defensive in nature, with a medium- to long-term horizon.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of CSWC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Comments (67)

Retire2020 profile picture
SA shows CSWC has a p/b of 1.1. Is that cheap for bdc?

Not all BDC's are created equal.

P/B of 1.1 is pretty cheap for a BDC like CSWC.
Retire2020 profile picture
@Bekster Thanks.
Raj Mehta profile picture
I’ve been long $CSWC in my IRA since 2020. Sadly, down 12%. But I am patient. My average cost basis is 20.54. Hoping for further recovery in price.
birder profile picture
I have a moderate position in CSWC which I have held for a few years. Most is in my IRA accounts since the dividends are 100% taxable.
The Dividend Collectuh profile picture
One of my favorite stocks in my portfolio. Long CSWC
Thanks for a really great article.
Gen Alpha profile picture
@jeffrg you're welcome. I'm glad you enjoyed it.
Long in Roth. I own due to internal management structure which I believe over time is a competitive advantage and track record. CWSC has increased the dividend and in recent years has paid supplemental dividends as well. The trading range has been huge but now much closer to the lower end for those considering entry level.
Gen Alpha profile picture
@stompers54 well put. Roth is an excellent place for this income stock.
KMR holder profile picture
Maybe internally managed BDCs deserve a premium to NAV, but I'm pretty sure that one of the reasons why some well run internally managed BDCs have not done as well for their investors is that investors have paid more to own them. What ever benefit they earn from lower management expenses can be offset by investors paying too much to own their shares.

Five year total return since December 1st, 2017:

CSWC 13.55% per year
ARCC 13.71% per year
OCSL 17.41% per year

CSWC has outperformed MAIN by a lot over those same five years. MAIN has returned to its investors 6.48% per year. Investors' returns have been less than the distribution yield.
lateralgs profile picture
@KMR holder

All true. But as always, what matters most is what each individual investor has paid for the shares they own, and when they bought them. Without considering the effect of distributions, our cost for our MAIN shares is around $27/sh average. So our returns and effective yield on expended capital in MAIN are very substantially above the tracked paper returns everybody looks at. Price paid matters a lot…as you already know, of course.
KMR holder profile picture
My problem with thinking like that is the lost opportunities you had in continuing to own MAIN at such high prices over time. There have been times at which you could have sold your MAIN shares, paid capital gains taxes and then reinvested in less expensive BDCs like ARCC and doubled your returns. In a tax deferred account you could have done even better as there would have been no tax drag at all.
It isn't what you paid that makes your profits. It is buying cheaply and selling when expensive.
lateralgs profile picture
@KMR holder

How do you know I have not sold shares? In fact, I have. I take profits…and losses in the case of taxable accounts…strategically. And how do you know whether I hold MAIN or any other investment in a tax deferred or taxable account? I own my largest dividend/regular income payers in IRAs, mostly Roth. Those include large positions in things like JEPI, JEPQ, DIVO, MAIN, ARCC, CSWC, CGBD and other holdings. Some of these I also own in taxable accounts after the Roth accounts are maxed-out.
Cristian Chierici profile picture
Nice article (Thank You).
My only concern about CSWC are their DIVIDEND COVERAGE and their OPERATING CASH FLOW that seems to be not enough to cover their debt position.
Someone read these factors differently from me..?
Gen Alpha profile picture
@Cristian Chierici thank you. NII is the standard measurement for dividend coverage capacity.
Cristian Chierici profile picture
@Gen Alpha Thank You very much for Your explanation..! Now things are clear. Another question for You: from the comments i don't understand IF the dividend IS OR NOT a ROC. Can You clarify this too, please?
I have been adding CSWC on dips.
Gen Alpha profile picture
@Dr. LouX we’ve been fortunate to have had plenty of dips.
@Gen Alpha Yes. I have bought some CSWC a bit too soon so my cost basis is approximately flat, but the dividend more than makes up for that.
Eileen Dover profile picture
@Dr. LouX Me too, holding on for those dividends.
petergo007 profile picture
thank you for the article!

May I kindly ask you please if it is correct that the distributions are mainly Return of Capital (ROC)

NRA investors enjoy owning shares that distribute dividends as ROC.

kindest thanks

lateralgs profile picture

This is the second time I have seen someone post that CSWC’s distributions are (or may be) primarily ROC. In fact, 100% of the distributions paid in 2021 were classified as ordinary dividends. In 2020, approximately 91% of the distributions were ordinary dividends and the remainder were qualified dividends. In 2019, approximately 52% of the distributions were long term capital gains, 41% were ordinary dividends, and 7% were qualified.

If Capital Southwest is now distributing primarily ROC in 2022, that would be a significant change.
Income4ever aka Cyclenut profile picture
Very odd that the Roc thing keeps popping up...
lateralgs profile picture
@Income4ever aka Cyclenut

Yeah. Rumors travel fast.

And correct on the ROC observation. My wife has owned units of an MLP for around 15 years now. I despise K-1 forms so refuse to own MLPs myself. But the great majority of the admittedly high distribution is classified as ROC. So over time her effective basis in the units for tax purposes has shrunk significantly. That’s great for current year tax considerations, but you face a potential giant capital gain and tax if you liquidate much later. It’s virtually all cap gain. So for sure that MLP will get sent to some heirs at some point, and my wife will just start taking the distributions as cash to spend in the meantime.

I finally jumped into this one a couple of weeks ago after watching it almost all year, likely first inspired by one of your articles. Big dips never coincided with available capital, but the stars have aligned to establish my base position before the next ex-date. Thanks!
Gen Alpha profile picture
@Manydoglady you’re welcome and good luck!
elliot_mllr profile picture
After owning CSWC in my tax qualified accounts for several years I have now added CSWC share to my currently taxable accounts as well because of the factors outlined in the above article.
Elliot Miller
Gen Alpha profile picture
@elliot_mllr I have it in both as well. Good investing to you.
@elliot_mllr Me too. Great minds think alike.
Income4ever aka Cyclenut profile picture
One of the oldest , since 1960s and definitely one of the best..
They have a JV partnership with MAIN and they have top shelf shareholders aligned friendly management.
Long Cswc looking to add on dips -$17.75
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