Dolby Goes Mute

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Don't say you weren't warned, Dolby (NYSE: DLB) investors. Earlier this week, I argued that based on its trailing numbers, and anticipated growth rate, Dolby was no bargain. I urged Fools to "stay neutral until you're convinced it's safe to do otherwise."

Judging from the stock's 5% rise over the last two days, few people heeded my advice. Now it's too late for them ... but not for us.

Dolby takes a dive
Dolby reported its fiscal fourth-quarter and year-end earnings last night, and the stock has already given up all the gains reaped earlier in the week, diving to a 7% loss:

• Revenues essentially flatlined at 0.5% growth for the quarter.
• Profits dropped 10% to $0.38 per share, although they were above analyst estimates of $0.33 per share.
• Free cash flow fell off a cliff -- down 24% year over year.

So basically, investors seeking an excuse to take profits today, after the stock's 64% climb off its January lows, didn't need to look hard to find a reason.

This stock goes to 11. (Figuratively speaking.) (We hope.)
But here's the good news: This sell-off is great news for Dolby longs. Sure, Q4 didn't work out so great. But check out the long-term story at Dolby. Over the past year, we've seen:

• Sales surge 12% to close just shy of $720 million.
• Profits spike 21% to $243 million.
• While free cash flow eked out a 3% gain in the midst of the worst recession since the Great Depression.

Dolby now boasts $259 million in annual free cash flow -- a figure greater than its reported annual income under GAAP. Viewed from one perspective, this means the stock trades for 18 times free cash flow. With analysts predicting only 14% 5-year growth at Dolby, that may look expensive. However, if you net out Dolby's cash, short-term and long-term investments totaling $941 million, and subtract its negligible long-term debt, what you're really looking at here is an enterprise valued at barely 14 times free cash flow -- the very definition of a fair price for a 14% grower.

Foolish takeaway
Now here's the kicker: Think to yourself -- who's going to replace Dolby as the leader in digital audio? Tiny DTS (Nasdaq: DTSI)? Not likely. Sony (NYSE: SNE). Please! They've got their hands full just trying to earn a profit, while fending off Nintendo and Microsoft (Nasdaq: MSFT) on games, and everyone from Panasonic (NYSE: PC) to Philips (NYSE: PHG) to Logitech International (Nasdaq: LOGI) in electronics.

Simply put, today's sell-off has finally given us the chance to own the premier name in audio entertainment at price more than fair. To me, that's an idea worth entertaining.