With its stock down 8.2% over the past three months, it is easy to disregard Dolby Laboratories (NYSE:DLB). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company's financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study Dolby Laboratories' ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Do You Calculate Return On Equity?

ROE 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:

8.0% = US$190m ÷ US$2.4b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.08 in profit.

What Is The Relationship Between ROE And 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

A Side By Side comparison of Dolby Laboratories' Earnings Growth And 8.0% ROE

On the face of it, Dolby Laboratories' ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 10%. Therefore, it might not be wrong to say that the five year net income decline of 2.2% seen by Dolby Laboratories was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Dolby Laboratories' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 16% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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?

In spite of a normal three-year median payout ratio of 46% (that is, a retention ratio of 54%), the fact that Dolby Laboratories' earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Dolby Laboratories has paid dividends over a period of nine years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

On the whole, we feel that the performance shown by Dolby Laboratories can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.