About this same time last year, I wrote an article entitled 3 Reasons To Own Dolby Labs. At the time, its stock was trading at $47.79 a share. In my bottom line summation my final line stated, "There might be a little downside left but that shouldn't scare value investors from buying. Dolby's (NYSE:DLB) on sale." Since then, it's dropped roughly 30% versus only about 1.5% decrease for the SPDR S&P MidCap 400 (ARCA:MDY). Looking back on my three reasons for buying its stock, I'll explain why I believe now, more than ever, it's priced to move.


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Then and Now

In last year's article, I compared the state of its business in February 2005 up to when it went public to April 2011, using its 2004 and 2010 fiscal years as reference points. What I found is that the company had significantly improved its revenues and profitability over the five years, yet its price-to-sales (P/S) had barely moved. On Apr. 21, 2010, its share price was 5.41 times sales. One year later, its stock is trading at about 4.3 times sales; a valuation that's 21% lower. Fiscal 2011 ended Sept. 30, 2011. Revenues increased 3.6% to $955.5 million and operating income was flat at $429.7 million. Its guidance for fiscal 2012 is for revenues of $910 million to $970 million with gross margins of 90%, approximately 200 basis points higher than in 2011 and 430 basis points in 2010. This is where things get a little soft. Assuming revenues hit the higher end of its 2012 guidance, operating margins should be around 41%, which is 950 basis points lower than in fiscal 2009. Barring an acquisition or two, the next 12 to 24 months will be slow growth in terms of both revenue and profits. Not to worry; it's just catching its breath.



Dolby Labs and Peers


Company


P/S




Dolby Labs (NYSE:DLB)


4.21


6.87


DTS (Nasdaq:DTSI)


5.02


11.48


SRS Labs (Nasdaq:SRSL)


2.98


36.64


Imax (Nasdaq:IMAX)


6.46


39.91



All in the Family

Looking back on my article from last year, I realize in hindsight that Ray Dolby's son, David, who sits on the board, left the company in February 2011. Therefore, although he's still on the board, he's no longer involved in the daily operation of the company, but does provide technology consulting. Interestingly, because Dolby repurchased over 4.1 million shares of its stock in 2011, the Dolby clan actually has a slightly higher percentage of the votes even though they sold off approximately 1.6 million shares this past year. Apparently, the Dolby's are still very much in control. As for the share repurchases, management paid an average of $49.47 a share between September 2010 and September 2011, which is roughly 28% below its high of $69.69. It's a decent showing.

SEE: A Breakdown Of Stock Buybacks



Products

Dolby's product revenues came down to earth in 2011 as most theaters completed their conversion to digital and 3-D in 2010. Dolby provides the digital media servers required to store and decrypt digital film files accounting for about 20% of its overall revenues in 2010; product sales were just 14% overall in 2011. As I reiterated in my article, it needs to make some tuck-in acquisitions with the $1 billion in cash it has on its books. As for its licensing revenue, which is its bread and butter, business is steady as she goes. In 2012, Dolby technology will be in 15% of the smartphones shipped to customers, up from almost nothing a year earlier. With the excellent margins generated by the licensing, the downside of its business model is virtually non-existent. Unless things change dramatically in 2012, Dolby will continue to be primarily an intellectual property business more than anything else and there's nothing wrong with that.



The Bottom Line

Dolby Labs is a cash generating machine so even when it's not growing revenues at a breakneck pace, it's making plenty for shareholders. At the end of December, Joel Greenblatt's second largest holding out of 644 stocks was Dolby Labs. I don't usually like to double-down but Dolby's too cheap to not recommend buying its stock.

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.



Tickers in this Article: DLB, DTSI, SRSL, IMAX

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