With a price-to-earnings (or "P/E") ratio of 33.2x Dolby Laboratories, Inc. (NYSE:DLB) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 18x and even P/E's lower than 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
The recently shrinking earnings for Dolby Laboratories have been in line with the market. One possibility is that the P/E is high because investors think the company can turn things around and break free from the broader downward trend in earnings. If not, then existing shareholders may be a little nervous about the viability of the share price.
How Is Dolby Laboratories' Growth Trending?
In order to justify its P/E ratio, Dolby Laboratories would need to produce outstanding growth well in excess of the market.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 2.8%. As a result, earnings from three years ago have also fallen 23% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 22% over the next year. Meanwhile, the rest of the market is forecast to only expand by 14%, which is noticeably less attractive.
In light of this, it's understandable that Dolby Laboratories' P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Key Takeaway
We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
As we suspected, our examination of Dolby Laboratories' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Dolby Laboratories with six simple checks on some of these key factors.
Of course, you might also be able to find a better stock than Dolby Laboratories. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.
