Has Dolby Labs Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Dolby Labs (NYSE: DLB  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Dolby Labs.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 17.4% Pass
  1-Year Revenue Growth > 12% 0.6% Fail
Margins Gross Margin > 35% 89.8% Pass
  Net Margin > 15% 31.6% Pass
Balance Sheet Debt to Equity < 50% 0.0% Pass
  Current Ratio > 1.3 8.64 Pass
Opportunities Return on Equity > 15% 17.7% Pass
Valuation Normalized P/E < 20 15.22 Pass
Dividends Current Yield > 2% 0.0% Fail
  5-Year Dividend Growth > 10% 0.0% Fail
       
  Total Score   7 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Dolby Labs last year, the company has kept its 7-point score. A sizable drop in its stock price has made Dolby's valuation more attractive, but revenue has come to a standstill in the past year, marking an abrupt halt to longer-term growth.

If you've ever been to a movie or listened to anything on your computer, you've almost certainly heard Dolby products in action. The company is behind the intellectual property that helps boost audio quality through digital technology.

Dolby shares performed horribly in 2011, and the culprit was a threat to its PC presence. Last summer, Dolby's CEO said that Microsoft (Nasdaq: MSFT  ) hadn't included Dolby Digital technology in its upcoming Windows 8 operating system. That spooked analysts and investors with fears that Dolby's dominance of the PC market was at risk. What that suggested is that Dolby might have to go directly to PC makers Hewlett-Packard (NYSE: HPQ  ) and Dell (Nasdaq: DELL  ) to make specific licensing arrangements with them.

But last night, Microsoft announced that Dolby will be included in the Windows 8 release. That sent shares soaring after-hours and should help reignite its growth trajectory going forward.

In addition, Dolby has moved its focus further upstream by targeting Netflix (Nasdaq: NFLX  ) and other video-streaming sources. By getting its technology involved at an earlier stage in the process, Dolby doesn't care whether users listen on a computer, TV, or mobile device -- it will still play a vital and profitable role in the process.

Earlier this week, Dolby made an interesting announcement: It won the naming rights for the Academy Awards venue, taking that honor away from now-bankrupt Eastman Kodak.If Dolby can reignite its growth and build up enough steam to pay a dividend, then it may well deserve an award of its own at some point in the future.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Dolby Labs isn't the perfect stock, but we have some ideas you may like better. Let me invite you to learn about three smart long-term stock plays in the Fool's latest special report. It's yours for the taking and is absolutely free, but don't miss out -- read it today.

Add Dolby Labs to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Microsoft. Motley Fool newsletter services have recommended buying shares of Microsoft, Netflix, and Dolby Laboratories, as well as writing covered calls on Dell and creating a bull call spread position in Microsoft. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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