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Is Dolby Laboratories, Inc. (DLB) Out of the Dog House Yet?

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As a starting point in my search for new ideas, I often look for companies with strong earnings yields and high returns on invested capital.

Why? Businesses with high returns on invested capital usually possess durable competitive advantages and demonstrate a knack for creating value for shareholders. When these companies also sport strong earnings yields, they often represent great potential opportunities for investors to beat the market.

This in mind, Dolby Laboratories, Inc. (NYSE:DLB) has piqued my interest following its strong earnings report last Monday. Of course, Dolby isn’t exactly a new idea; thanks to persistent worries about declining revenue in its core segments, the undervalued 47-year-old audiophile occupied a spot in my screens for the better part of 2012.

Dolby Laboratories, Inc. (NYSE:DLB)Even still, as evidenced by the quick 6% pop in its shares after the announcement, Dolby’s numbers were undeniably solid, as it bested analyst estimates by $0.05 with first-quarter earnings per share of $0.50. Dolby’s quarterly revenue of $236.6 million also beat estimates of $221 million and, though the company issued relatively conservative guidance for the current quarter, it also raised the lower end of its full-year revenue guidance and now expects to see revenue for fiscal 2013 between $910 million and $950 million. Despite the encouraging numbers and the initial pop, however, Dolby quickly gave back the gains as investors remained unconvinced the worst is over.

Before we dig further, let’s see how some of Dolby’s latest key metrics stack up to its closest publicly traded competitor, DTS Inc. (NASDAQ:DTSI) :

Metric Dolby DTS
Market capitalization $3.28 billion $366 million
Debt-to-equity ratio 0.00 0.17
Current ratio 4.28 4.61
P/E ratio (TTM) 13 N/A
Estimated forward P/E ratio 15.83 17.47
Gross margin 89.18% 90.53%
Net margin 21.75% (8.73%)
Return on invested capital 14.49% (5.44%)

Source: YCharts. TTM = trailing 12 month.

Even after spending more than $400 million in December to pay a massive $4 per share dividend, Dolby still sports a sterling balance sheet with no debt and $743 million in cash reserves. In addition, its current price-to-earnings ratio of 13 gives it a respectable earnings yield of 7.69%, and it remains solidly profitable with gross margin of more than 89% and net margin just under 22%. Lastly, Dolby’s ROIC of 14.49% shows it’s still capable of creating shareholder value by reinvesting capital in its business.

At first glance, competition doesn’t seem to be much of an issue. Considering the table above, the comparison between Dolby and DTS doesn’t seem very fair. Heck, Dolby’s cash reserves are twice as large as DTS’ entire market capitalization, and DTS still hasn’t fully recovered from its most recent quarter’s $19.1 million loss despite a year-over-year revenue increase of 8%. However, the loss was primarily due to the accounting treatment of its July acquisition of SRS Labs, Inc. (NASDAQ:SRSL). When the two smaller companies are finally integrated, you can be sure they’ll do everything in their power to give Dolby a good fight.

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