Close the Loop Ltd's (ASX:CLG) Share Price Is Matching Sentiment Around Its Earnings

Close the Loop Ltd's (ASX:CLG) price-to-earnings (or "P/E") ratio of 16.6x might make it look like a buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 19x and even P/E's above 37x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Recent times have been pleasing for Close the Loop as its earnings have risen in spite of the market's earnings going into reverse. One possibility is that the P/E is low because investors think the company's earnings are going to fall away like everyone else's soon. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

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Does Growth Match The Low P/E?

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

Retrospectively, the last year delivered an exceptional 35% gain to the company's bottom line. Still, EPS has barely risen at all from three years ago in total, which is not ideal. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 4.6% per year as estimated by the one analyst watching the company. Meanwhile, the broader market is forecast to expand by 17% per annum, which paints a poor picture.

With this information, we are not surprised that Close the Loop is trading at a P/E lower than the market. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

What We Can Learn From Close the Loop'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 Close the Loop maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Close the Loop, and understanding 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.