Over the past six months, Dolby Laboratories’s shares (currently trading at $54.39) have posted a disappointing 16.3% loss, well below the S&P 500’s 11.6% gain. This was partly due to its softer quarterly results and might have investors contemplating their next move.

Is now the time to buy Dolby Laboratories, or should you be careful about including it in your portfolio? See what our analysts have to say in our full research report, it’s free.

Why Do We Think Dolby Laboratories Will Underperform?

Even though the stock has become cheaper, we're sitting this one out for now. Here are three reasons there are better opportunities than DLB and a stock we'd rather own.

1. Long-Term Revenue Growth Disappoints

A company’s long-term sales performance is one signal of its overall quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Over the last five years, Dolby Laboratories grew its sales at a weak 2.1% compounded annual growth rate. This was below our standards.

2. Long Payback Periods Delay Returns

The customer acquisition cost (CAC) payback period represents the months required to recover the cost of acquiring a new customer. Essentially, it’s the break-even point for sales and marketing investments. A shorter CAC payback period is ideal, as it implies better returns on investment and business scalability.

Dolby Laboratories’s recent customer acquisition efforts haven’t yielded returns as its CAC payback period was negative this quarter, meaning its incremental sales and marketing investments outpaced its revenue. The company’s inefficiency indicates it operates in a highly competitive environment where there is little differentiation between Dolby Laboratories’s products and its peers.

3. Shrinking Operating Margin

While many software businesses point investors to their adjusted profits, which exclude stock-based compensation (SBC), we prefer GAAP operating margin because SBC is a legitimate expense used to attract and retain talent. This metric shows how much revenue remains after accounting for all core expenses – everything from the cost of goods sold to sales and R&D.

Analyzing the trend in its profitability, Dolby Laboratories’s operating margin decreased by 2 percentage points over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its operating margin for the trailing 12 months was 18.5%.

Final Judgment

Dolby Laboratories doesn’t pass our quality test. After the recent drawdown, the stock trades at 3.6× forward price-to-sales (or $54.39 per share). This multiple tells us a lot of good news is priced in - we think there are better opportunities elsewhere. We’d recommend looking at a top digital advertising platform riding the creator economy.

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