IDCC - InterDigital: Relatively Better And Relatively Worse

2023-09-07 21:54:07 ET

Summary

• InterDigital, Inc. shares have declined about 13.8% in the past two months, making it a less risky investment.
• The company's financial performance has been positive, with revenue, operating income, and net income all increasing significantly.
• IDCC stock is currently not cheaply priced, and the dividend yield is below the risk-free rate, so it may not be a good time to buy.

It's been just under two months since I sold the last of my stake in InterDigital, Inc. ( IDCC ), and in that time, the shares have declined about 13.8% against a gain of about 1.1% for the S&P 500. A wiser, more mature person than me would not take this opportunity to brag about getting out of the stock just before it fell in price. Such a theoretical person would refrain from such odious behaviour because it would then open them up for criticism when their timing is particularly awful. Thankfully I'm not burdened by such wisdom, so unbearable levels of self-congratulation are going to permeate this article. In seriousness, an investment that's trading at $81.90 is, by definition, a less risky proposition than the same thing when it's priced at $95.51. Given that, I thought I'd review the name yet again to see if it makes sense to buy or not. I'll make that determination by comparing the most recent financials to the current valuation.

I realise that people are busy, and I realise that people would rather not read someone brag at them, and for that reason, I'm going to put a "thesis statement" at the beginning of this article. This allows you, the reader, to get into the article, get the gist of my thinking and get out before you're exposed to too much stomach churning self congratulation. You're welcome. I really like the state of the financial world with this company. It's growing very nicely, and the capital structure is among the strongest I've seen. Additionally, the buyback program was actually good for shareholders in my view. This is why it's difficult for me to stay on the sidelines, but that's exactly what I'm going to do. Investing is about spending units of risk to make some return, and the relative risk of this stock is too great for the potential returns here in my view. Specifically, the shares are definitionally more risky than the risk free government bond, but they're paying investors far less in terms of cash flow. In addition, the shares themselves are not cheaply priced by some measures. So, I'm going to keep my proverbial "powder" dry, and buy government bonds in lieu of shares. If this were September of 2020 when the yield on the 20 year Treasury Bond was 1.2%, I may take a different view, but when I can earn 4.55% on a 20 year government bond? Fuhgeddaboudit!

Financial Snapshot

I think the most recent financial performance has been generally good, with revenue, operating income, and net income in 2023 higher by 34.5%, 78%, and 225% respectively. Earnings per share increased at an even higher rate (254%) because of the buyback activity here. The share count has dropped by fully 14.5% from last year to this, as a result of an aggressive buyback program in 2023. In case you forgot, in my previous missive on this name I concluded that the buyback was reasonable, though I did fret that the share price might drop if the company didn't commit future resources to buying back stock, since the buyback represented a material amount of daily volume.

I continue to believe that the capital structure remains rock solid, given that cash and short term investments represent about 138% of long term debt outstanding. That written, I would like to see the company pay down some of its debt because interest expenses more than doubled from the year ago period. The dividend, which has remained unchanged since 2018, seems to be well covered, but it'd be even more well covered if interest expenses fell from here. I'll admit that that's a minor problem, but I felt compelled to mention it.

Given the above, I'd be very happy to buy back into the stock at the right price.

The Stock

If you're one of my regulars, you know that I consider the stock and the business to be two distinctly different things, which is why I write about them separately. The stock is a piece of virtual paper that gets traded around in a public market, and it's based on the crowd's ever changing views about the health of a given business, the demand for "stocks" as an asset class, and so on. The stock represents a claim on the future cash flows of a business, and the reality is that the more you pay for $1 of future earnings, the lower will be subsequent returns. This is as much of an iron "law" as you're going to find in investing. For that reason, I'm loathe to overpay for an asset. My skittishness sometimes costs me gains, but as in the case of InterDigital, my insistence on getting out when valuation gets too extreme can help me sidestep losses. This is important in my view, because losses of a certain size hurt much more than gains of the same size make me happy. I'd rather miss gains from some potential theoretical future than sustain actual losses today. So, for me, the cheapness of a stock is really, really important.

As my regulars know, I measure the cheapness of a stock in a few ways, ranging from the simple to the more complex. On the simple side, I look at the ratio of price to some measure of economic value, like earnings, free cash flow, and the like. I like to see a stock trading at a discount to both its own history and the overall market. I decided to sell my remaining InterDigital when the shares hit a price to sales ratio of 5 times, and the dividend yield was about 300 basis points lower than the risk free rate. Fast forward to the present, and the price to sales ratio is about 10% cheaper, and the dividend yield is now "only" about 285 basis points below the risk free rate .

As I wrote above, in addition to looking at simple ratios, I also look at more complex measures of valuation. In particular, I want to try to unpack the assumptions currently embedded in price. If you read me regularly, you know that I rely on the work of Professor Stephen Penman, and increasingly Mauboussin and Rappaport to do this. The Penman book is called "Accounting for Value" and Mauboussin and Rappaport's updated "Expectations Investing." This approach uses stock price itself as a source of information. This method involves "reverse engineering" the assumptions that cause the current price. I'll admit that this approach involves some high school algebra, and some people find that challenging.

Anyway, according to my approach, the market is currently forecasting a growth rate of about 5.5% for InterDigital going forward. This seems fairly optimistic, which is generally not great in my view.

Given the above, I'm tempted to take a small speculative position in the stock, though, as is atypical for me, I'm going to not give into this temptation. The shares are not cheaply priced, and, by the more complex valuation measure that I use, they're actually rather expensive. Additionally, the dividend yield remains nearly 3% below the risk free rate. So until such time as the company raises the dividend, I see no reason to take on more risk to earn less money. I'll revisit this perspective if the company raises the dividend, but for now, I'm going to remain on the sidelines.

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