Close the Loop Ltd's (ASX:CLG) P/E Is On The Mark

Close the Loop Ltd's (ASX:CLG) price-to-earnings (or "P/E") ratio of 29.5x might make it look like a strong sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 14x and even P/E's below 7x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Close the Loop hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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Is There Enough Growth For Close the Loop?

The only time you'd be truly comfortable seeing a P/E as steep as Close the Loop's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a frustrating 50% decrease to the company's bottom line. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Looking ahead now, EPS is anticipated to climb by 25% per year during the coming three years according to the one analyst following the company. Meanwhile, the rest of the market is forecast to only expand by 13% each year, which is noticeably less attractive.

With this information, we can see why Close the Loop is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Close the Loop's P/E?

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Close the Loop maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Close the Loop (at least 1 which doesn't sit too well with us), and understanding these should be part of your investment process.

If you're unsure about the strength of Close the Loop's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.