2023-07-11 05:15:53 ET
Summary
- Shares in InterDigital Inc. have risen by 33% in the past five months, outperforming the S&P 500's gain of 5.25%.
- The company spent over $203m on share buybacks in Q1 2022, prompting questions about what will happen if this activity slows down.
- Despite impressive financial performance, I plan to sell his remaining shares, believing the majority of good news is already priced in and the risk-reward balance no longer makes sense.
It’s been about 5 months since I decided to take some profits on InterDigital, Inc. ( IDCC ), and in that time the shares have exploded higher by about 33%, against a gain of 5.25% for the S&P 500. While it’s gratifying that I enjoyed some of this run higher, it would have been better had I not sold some of my stake back in early February, obviously. Today I want to try to work out whether or not it makes sense to add to my position or sell my remaining stake, or hold. I’ll make that determination by looking at the latest financials, and comparing those to the valuation here. I want to pay particular attention to the recent buyback activity, because the company spent just over $203 million on that activity during the first quarter of the year.
Before getting into the article proper, I thought it’d be fun for me to step up on a soapbox and sermonize at all of you. You’re very welcome. We’re told to be “greedy when others are fearful, and fearful when others are greedy.” The obvious message there is that we want, in general, to avoid stocks when the crowd get overly excited about owning them. In my experience, this is one of the most challenging aspects of investing well: leaving a party that’s going in full swing. You need to come to the view that the current state is the best state that will ever be, or at least that most of the gains have been wrung out of a given investment. It’s not easy, and it’s impossible to be perfect at this. You might sell a stock, only to watch it continue to soar higher in price. If you’re not greedy (a necessary precondition to investing well in my view), this shouldn’t be too much of a problem.
A great many people want more than they can get from bullet points and a title, but want much less than they get from an article. For those people, I write a thesis statement and put it approximately near the start of my article. I do this because I’m obsessed with making the lives of my readers as pleasant as possible. I’m going to be selling my remaining shares today. The reason for this is that I think the vast majority of good news is already priced in. Additionally, although the recent buyback activity was done at a valuation that is reasonable, it represented a significant percentage of the daily volume, prompting questions about what happens if and when buyback activity slows. I think this is a wonderful business, I’m just no longer enamoured of IDCC stock. I think the shares may continue higher, given the slew of recent analyst upgrades, but I’m content taking my money and buying risk free investments at this point.
Financial Snapshot
In my view, the financial performance over the past quarter has been as close to flawless as I’ve seen in some time. The top and bottom lines have grown by 99% and 485% respectively from the same period in 2022. When compared to the pre-pandemic era, the results are even more impressive, with the latest quarter being about 195% higher than the same period in 2019, and net income swung from a loss of about $2.8 million back then to a profit of over $105 million recently.
Given this extraordinary cash flow generating power, I’m surprised that the company took on an additional $186 million in debt. This isn’t a problem for the moment, but at the current rate of growth it inevitably will, so I’m keeping an eye on it. That written, the company’s capital structure remains extraordinarily strong in my view, as cash and short term investments represent about 156% of long term debt at the moment. Additionally, I’ve pulled the following schedule of contractual obligations from the latest 10-K for your enjoyment and edification, and it shows that there are no significant calls on cash for several years. In my view, there’s very little risk of a credit or solvency event here. The dividend is very secure.
One thing that did stand out to me when reviewing the latest financial results was the buyback, given that the company spent $203 million on this activity for the first three months of the year.
So by way of background, from the middle of February of this year to May 2, the company retired 2,926,327 shares. Additionally, from January 1 to March 31, the company spent $203,381,000 on share buybacks, or $67,793,670 per month. So, we don’t yet have figures for amounts spent on buybacks during April, so I’m going to make a simplifying assumption and suggest that the company spent the average per month figure on buybacks during the month of April as it did for each of the previous three months.
Given the above, I’m working on the assumption that over the 2 ½ months from mid-February to early May, the company spent a total of $169,484,165 to retire the aforementioned 2,926,327 shares. Using the arithmetic skills so skillfully beaten into me by the good sisters at Holy Spirit School decades ago, I’ve worked out that the company retired each of these shares at an average price of $57.91.
If you read my stuff regularly, you know that when I judge the quality of a buyback, I don’t simply decide it’s “good” if the buyback price is below the current market price, and “bad” if the share price is currently below the buyback level. I want to see the shares retired when they were trading at a reasonable valuation. So, please put a pin in the $57.91 figure, as we’ll be returning to it anon. Before leaving the issue of the buyback, I think it’s worth noting that over the past 65 days, the volume has been about 374,000 shares . So, the company’s activities represented about 8 days of volume, or about 15% of the 53 market days in question.
Anyway, given all of the above, I’d be very happy to add to my stake at the right price.
The Stock
If you're a regular, you may already know what I’m going to write, but that won’t stop me from writing it. I consider the stock and the business to be very different things. InterDigital improves develops, enhances, and sells wireless communication solutions. The stock that we buy and sell is a slip of virtual paper that gets traded around by a crowd that drives the shares up and down based on a host of factors, including what some fashionable analyst might say about the underlying company.
Additionally, a stock may be bid up in price simply because the crowd’s feeling buoyant about equities as a group. Additionally, the stock may be affected by the change in interest rates. To hammer this point home, because some people believe that “we don’t buy stocks, we buy businesses” for some reason, consider the recent performance of InterDigital. If an investor decided that they like this business, and finally bought on June 30, they are down about 3% today. Had the same investor waited six days, they would not have suffered this loss, and would be flat today. The company didn’t change that much in 6 days. We buy stocks, and the price at which you buy stocks really, really matters.
In my experience, the only way to profitably trade stocks is by spotting discrepancies between expectations and subsequent reality. If the market is unreasonably optimistic, you avoid the stock, and if the market is overly pessimistic, you buy. Additionally, another way of writing "overly pessimistic" is "cheap." I like cheap shares because they have that great combination of lower risk and higher potential reward. They're lower risk because much of the bad news has already been "priced in." Additionally, cheap shares are potentially greater reward because a small bit of good news has the potential to send the shares skyward.
I measure the relative cheapness of shares in a few ways, ranging from the simple to the more complex. On the simple side, I like to look at the ratio of price to some measure of economic value, like earnings, sales, book value, and the like. I want to see the company trading at a discount to both the overall market and its own history. When I last reviewed InterDigital, the market was paying 4.8 times sales, and the dividend yield was about 1.97%, or significantly lower than the then risk free rate. This contrasted to my original buy when the shares were trading at a price to sales of 3, and a dividend yield of exactly 3%. Fast forward to the present, and the market has gotten even more optimistic, and is paying even more for $1 of sales, and the yield is now about 3% lower than the risk free rate .
As I wrote earlier, I want to buy when expectations about the future of a given company are relatively dour. This is why I think it’s worthwhile to review expectations, and assumptions about the future again. The way I try to work out the assumptions embedded in the current stock price is by turning to works like Penman's "Accounting for Value" and Mauboussin and Rappaport's "Expectations Investing." The approach taken by all of these writers is to treat the stock price itself as a great source of information about what the market is currently "thinking." Applying this approach to InterDigital today suggests the market is assuming that earnings will grow at a rate of about 7% from current levels. Although the growth is impressive, I think it must eventually slow, and it seems that a couple of analysts agree with me.
Revisiting the Buyback
As you may recall, I estimated that the company retired shares at a price of just under $58 per share. That works out to a price to sales figure of about 3.1 times, which I consider to be a very reasonable rate. Thus, I think the $203 million spent on buybacks so far this year was a reasonable use of owner capital. I would note also that this buyback activity represents a large percentage of total volume, suggesting that the price may drop if the company doesn’t continue to commit resources to retiring shares.
Given all of the above, I’m going to sell my remaining shares, and will park the capital in a risk free investment. I may lose further gains from here, but the risk-reward no longer makes sense to me here.
For further details see:
Hanging Up On InterDigital