When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") above 20x, you may consider Hercules Capital, Inc. (NYSE:HTGC) as an attractive investment with its 9.8x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

There hasn't been much to differentiate Hercules Capital's and the market's earnings growth lately. One possibility is that the P/E is low because investors think this modest earnings performance may begin to slide. If not, then existing shareholders have reason to be optimistic about the future direction of the share price.

Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like Hercules Capital's to be considered reasonable.

Taking a look back first, we see that there was hardly any earnings per share growth to speak of for the company over the past year. The lack of growth did nothing to help the company's aggregate three-year performance, which is an unsavory 29% drop in EPS. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings growth is heading into negative territory, declining 4.3% over the next year. Meanwhile, the broader market is forecast to expand by 15%, which paints a poor picture.

With this information, we are not surprised that Hercules Capital is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Key Takeaway

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

As we suspected, our examination of Hercules Capital's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Hercules Capital (1 is potentially serious) you should be aware of.

You might be able to find a better investment than Hercules Capital. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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