Monday, August 8, 2011

Dolby's Sound Gets a Bit Muffled

My father always liked investing in top-notch audio and video gear. In the early 1980s, he laid down $400 for a VCR. That's about $1,100 in today's money. And that was on a pressman's salary.
When I think back to that audio and video gear, I can remember the words "Dolby Sound" appearing on quite a few of them.
It was a mark of quality, regardless of brand or device type.
Over the years, Dolby (DLB) has figured out how to get its technology into just about everything -- cassette decks, CD players, movies, home theater systems ... You name it.
That's why I was willing to give the company a shot after two weak quarters sent its stock price tumbling from a high near $70 to just over $40.
The underlying concern with the company was less about what it was earning right now, and more about what it might be earning in the future. Dolby made a lot of money on PCs. Its technology was built in to operating system and optical drives.
The transition from desktops and laptops to smartphones and tablets presents the company with a new challenge.
Buying the stock this spring was a vote of confidence in Dolby. I believed its technology was still seen as a necessity by most quality tech makers, and that because of that, Dolby would navigate its way through yet another technological change.

And then the curveball
That confidence was shaken last week when the company dropped a shocker on investors during its conference call. It revealed that it's not in the current version of Windows 8 that's still in development. It had long been included in the previous Windows versions.
Wall Street took notice. There were immediate downgrades. The stock, already down over the past few months, plummeted another 18%.
So what's an individual Dolby investor to think?
On one hand, Windows 8 will represent only a small piece of Dolby's market. And there's a chance Dolby sound will be included on the final version, which is the only one that counts. The company is also working with equipment manufacturers to get the technology directly on the computers and other gadgets.
So, this may be much ado about nothing, and since Dolby's full quarter actually beat analysts' expectations, maybe things are not looking bad. Maybe, at a price-to-earnings ratio under 12, Dolby is a screaming buy.
On the other hand, the fact that Microsoft (MSFT) has not included Dolby on the operating system so far raises a big question: Do tech makers still consider Dolby necessary to their products?
If not, the company has much more to overcome than I'd previously bargained for.

Where to go from here?
This has left me at a crossroads with the stock.
I have four options:
  • Sell at a 33% loss and look for better opportunities.
  • Sell out of part of my position, but still give DLB a chance.
  • Stand pat and don't overreact to what might turn out to be non-news when all's said and done.
  • Treat the plunge as an overreaction and buy more DLB.
I have not decided a course of action, but I'm leaning toward option No. 2, and getting out of part of my position as a way to hedge my bets. This is a blow that may take some time to recover from. But manufacturers, Including Apple (AAPL) and still including Dolby products on their systems.
I'll be thinking more and watching the price movements and news over the next few days to help me decide.

What would you do?

See my portfolio here.

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