Numbers can lie -- but they're the best first step in determining whether a stock is a buy. In this series, we use some carefully chosen metrics to size up a stock's true value based on the following clues:

  • The current price multiples.
  • The consistency of past earnings and cash flow.
  • How much growth we can expect.

Let's see what those numbers can tell us about how cheap digital wireless solutions provider InterDigital (Nasdaq: IDCC) might be.

The current price multiples
First, we'll look at most investors' favorite metric: the P/E ratio. It divides the company's share price by its earnings per share (EPS) -- the lower, the better.

Then, we'll take things up a notch with a more advanced metric: enterprise value to unlevered free cash flow. This divides the company's enterprise value (basically, its market cap plus its debt, minus its cash) by its unlevered free cash flow (its free cash flow, adding back the interest payments on its debt). Like the P/E, the lower this number is, the better.

Analysts argue about which is more important -- earnings or cash flow. Who cares? A good buy ideally has low multiples on both.

InterDigital has a P/E ratio of 9.4 and an EV/FCF ratio of 6.2 over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, InterDigital has a P/E ratio of 14.2 and a five-year EV/FCF ratio of 4.7.

A one-year ratio under 10 for both metrics is ideal. For a five-year metric, under 20 is ideal.

InterDigital is a mouthwatering four for four on hitting the ideal targets, but let's see how it compares against some other companies with valuable patents and companies across the communications equipment industry: 

Company

1-Year P/E

1-Year EV/FCF

5-Year P/E

5-Year EV/FCF

InterDigital 9.4 6.2 14.2 4.7
Cisco Systems (Nasdaq: CSCO) 16.4 10.8 18.3 11.2
Qualcomm (Nasdaq: QCOM) 22.8 16.5 27.0 17.8
Sonus Networks (Nasdaq: SONS) 121.0 18.2 NM 54.8


Source: Capital IQ, a division of Standard & Poor's; NM = not meaningful.

Numerically, we've seen how InterDigital's valuation rates on both an absolute and relative basis. Next, let's examine ...

The consistency of past earnings and cash flow
An ideal company will be consistently strong in its earnings and cash flow generation.

In the past five years, InterDigital's net income margin has ranged from 9.1% to 54.8%. In that same time frame, unlevered free cash flow margin has ranged from 40.2% to 110.4%.

How do those figures compare with those of the company's peers? See for yourself:




Source: Capital IQ, a division of Standard & Poor's; margin ranges are combined.

Additionally, over the last five years, InterDigital has tallied up 5 years of positive earnings and 5 years of positive free cash flow.

Next, let's figure out ...

How much growth we can expect
Analysts tend to comically overstate their five-year growth estimates. If you accept them at face value, you will overpay for stocks. But while you should definitely take the analysts' prognostications with a grain of salt, they can still provide a useful starting point when compared to similar numbers from a company's closest rivals.

Let's start by seeing what this company's done over the past five years. In that time period, InterDigital has put up past EPS growth rates of 84.8%. Meanwhile, Wall Street's analysts expect future growth rates of 15%.

Here's how InterDigital compares to its peers for trailing five-year growth:


Source: Capital IQ, a division of Standard & Poor's; EPS growth shown.

And here's how it measures up with regard to the growth analysts expect over the next five years:



Source: Capital IQ, a division of Standard & Poor's; estimates for EPS growth.

The bottom line
The pile of numbers we've plowed through has shown us how cheap shares of InterDigital are trading, how consistent its performance has been, and what kind of growth profile it has -- both on an absolute and a relative basis.

The more consistent a company's performance has been and the more growth we can expect, the more we should be willing to pay. We've gone well beyond looking at a 9.4 P/E ratio.

InterDigital's portfolio of initial numbers is impressive. I'll be looking further into it. A key problem with a company like InterDigital is assessing the strength and longevity of its strong intellectual property. While it might hold strong patents, analysts need to take pains to measure how long the underlying technologies InterDigital has patents in will be successful, and how strong InterDigital is in enforcing its IP within the mobile and communications industry.

 If you also find InterDigital's numbers compelling, don't stop. Continue your due diligence process until you're confident that the initial numbers aren't lying to you.

Interested in reading more about any of these stocks? Add them to My Watchlist to find all of our Foolish analysis on this stock.

Anand Chokkavelu doesn't own shares in any company mentioned. InterDigital is a Motley Fool Stock Advisor choice. The Fool has written calls (bull call spread) on Cisco Systems. The Fool owns shares of Qualcomm. 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.