Dolby Laboratories, Inc.'s (NYSE:DLB) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Dolby Laboratories (NYSE:DLB) has had a great run on the share market with its stock up by a significant 18% over the last three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Specifically, we decided to study Dolby Laboratories' ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Dolby Laboratories

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Dolby Laboratories is:

11% = US$265m ÷ US$2.5b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.11 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Dolby Laboratories' Earnings Growth And 11% ROE

When you first look at it, Dolby Laboratories' ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 12%. But then again, Dolby Laboratories' five year net income shrunk at a rate of 3.6%. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.

So, as a next step, we compared Dolby Laboratories' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 18% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for DLB? You can find out in our latest intrinsic value infographic research report.

Is Dolby Laboratories Making Efficient Use Of Its Profits?

Dolby Laboratories has a high three-year median payout ratio of 50% (that is, it is retaining 50% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Dolby Laboratories by visiting our risks dashboard for free on our platform here.

Additionally, Dolby Laboratories has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Dolby Laboratories. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Dolby Laboratories' past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.