Time to Sell InterDigital?

Should you sell InterDigital (Nasdaq: IDCC  ) today?

The decision to sell a stock you've researched and followed for months or years is never easy. If you fall in love with your stock holdings, you risk becoming vulnerable to confirmation bias -- listening only to information that supports your theories, and rejecting any contradictions.

In 2004, longtime Fool Bill Mann called confirmation bias one of the most dangerous components of investing. This warning has helped my own personal investing throughout the Great Recession and the recent volatility throughout early August. In this series, I want to help you identify potential sell signs on popular stocks within our 4-million-strong Fool.com community.

Today I'm laser-focused on InterDigital, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, InterDigital has risen 192.6% versus an S&P 500 return of 9.1%. Investors in InterDigital have every reason to be proud of their returns, but is it time to take some off the top? Not necessarily. Short-term outperformance alone is not a sell sign. The market may be just beginning to realize the true, intrinsic value of InterDigital. For historical context, let's compare InterDigital's recent price to its 52-week and five-year highs. I've included a few other businesses that are also benefitting from the boom in connected devices driving large amounts of data that growth-oriented investors might be considering:

Company

Recent Price

52-Week High

5-Year High

InterDigital $75.72 $82.50 $82.50
Riverbed Technology (Nasdaq: RVBD  ) $24.57 $44.70 $44.70
Infinera (Nasdaq: INFN  ) $6.87 $12.90 $30.00
Emulex (NYSE: ELX  ) $6.87 $12.97 $23.80

Source: Capital IQ, a division of Standard & Poor's.

As you can see, InterDigital is down from its 52-week high. If you bought near the peak, now's the time to think back to why you bought it in the first place. If your reasons still hold true, you shouldn't sell based on this information alone.

Potential sell signs
First up, we'll get a rough idea of InterDigital's valuation. I'm comparing InterDigital's recent P/E ratio of 31.2 to where it's been over the past five years.

Source: Capital IQ, a division of Standard & Poor's.

InterDigital's P/E is higher than its five-year average, which could indicate the stock is overvalued. A high P/E isn't always a bad sign, since the company's growth prospects may also be increasing alongside the market's valuation. However, it definitely indicates that, on a purely historical basis, InterDigital looks expensive.

Now, let's look at the gross margins trend, which represents the amount of profit a company makes for each $1 in sales, after deducting all costs directly related to that sale. A deteriorating gross margin over time can indicate that competition has forced the company to lower prices, that it can't control costs, or that its whole industry's facing tough times. Here is InterDigital's gross margin over the past five years:



Source: Capital IQ, a division of Standard & Poor's.

InterDigital is having no trouble maintaining its gross margin, which tends to dictate a company's overall profitability. This is solid news; however, InterDigital investors need to keep an eye on this over the coming quarters. If margins begin to dip, you'll want to know why.

Next, let's explore what other investors think about InterDigital. We love the contrarian view here at Fool.com, but we don't mind cheating off our neighbors every once in a while. For this, we'll examine two metrics: Motley Fool CAPS ratings and short interest. The former tells us how Fool.com's 180,000-strong community of individual analysts rate the stock. The latter shows what proportion of investors are betting that the stock will fall. I'm including other peer companies once again for context.

Company

CAPS Rating
(out of 5)

Short Interest
 (% of float)

InterDigital **** 12.8
Riverbed Technology **** 4.6
Infinera ***** 7.3
Emulex ** 6.1

Source: Capital IQ, a division of Standard & Poor's.

The Fool community is rather bullish on InterDigital. We typically like to see our stocks rated at four or five stars. Anything below that is a less-than-bullish indicator. I highly recommend you visit InterDigital's stock pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a high 12.8%. This typically indicates that large institutional investors are betting against the stock.

Now, let's study InterDigital's debt situation, with a little help from the debt-to-equity ratio. This metric tells us how much debt the company's taken on, relative to its overall capital structure.

Source: Capital IQ, a division of Standard & Poor's.

InterDigital has done a good job of reducing its already miniscule debt over the past five years. When we take into account increasing total equity over the same time period, this has caused debt-to-equity to decrease, as seen in the above chart. Based on the trend alone, that's a good sign. I consider a debt-to-equity ratio below 50% to be healthy, though it varies by industry.  

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If InterDigital had to convert its current assets to cash in one year, how many times over could the company cover its current liabilities? As of the last filing, InterDigital has a current ratio of 4.82. This is a healthy sign. I like to see companies with current ratios equal to or greater than 1.5.

Finally, it's highly beneficial to determine whether InterDigital belongs in your portfolio -- and to know how many similar businesses already occupy your stable of investments. If you haven't already, be sure to put your tickers into Fool.com's free portfolio tracker, My Watchlist. You can get started right away by clicking here to add InterDigital.

The final recap

InterDigital has failed only two of the quick tests that would make it a sell. This is great, but does it mean you should hold your InterDigital shares? Not necessarily. Just keep your eye on these trends over the coming quarters.

In order to do that, I strongly recommend clicking here to add InterDigital to My Watchlist  to help you keep track of all of our ongoing coverage of the company.

Jeremy Phillips does not own shares of the companies mentioned.

The Motley Fool owns shares of Infinera. Motley Fool newsletter services have recommended buying shares of InterDigital, Infinera, and Riverbed Technology. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 23, 2011, at 9:13 AM, mainelegal wrote:

    Not a particularly good take in IDCC at the moment, since it is undergoing an auction of the company as an attempt to realize the intrinsic value of its hundreds of wireless patents and other associated technologies.

  • Report this Comment On August 23, 2011, at 3:23 PM, popsie100 wrote:

    Your analysis makes no sense. IDCC's patents and its engineers are its' most valuable assets, and you have made no attempt to value either. In a situation like this, when a company has put itself up for sale, your orthodox approach to valuation is not relevant. If this is this is the best you can do, why am I paying for your advice?

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