NEW YORK (TheStreet) -- Investors lapped up shares of Yahoo! (YHOO) in 2013 like pudding on Scooby Doo's nose. The key justification and catalyst propelling Yahoo!'s stock to new 52-week highs may surprise you, but it's the reason I became extremely positive on this one.
After analyzing the income and balance sheets, I couldn't help but subscribe to the bull thesis; from the time I wrote Yahoo! was a buy in "Yahoo! has room to grow," shares increased significantly.
With shares trading near $39.50, is it time to take the money and run? I don't think so, and I'm not alone. TheStreet's Chris Laudani arrived at the same conclusion in a Real Money piece earlier this week. With that said, hedging while the stock and market are at all-time highs isn't crazy either. I will show you how to hedge your position or gain new exposure using options that will help temper your risk.
First, let's take a look under the hood and see why Yahoo! shareholders are walking around grinning ear to ear.
Thanks to co-founder and former CEO Jerry Yang's fruitful investments, Yahoo! may encompass more with hedge funds than technology companies. The company's investments in Alibaba and Yahoo! Japan account for almost all the stock appreciation in 2013. That's right; Marissa Mayer, the latest and I think the greatest in a series of CEOs hasn't added much if any new value....yet.
Compared to online competitors Microsoft (MSFT) and Google (GOOG), Yahoo! appears to enjoy strong shareholder confidence based on the trailing earnings multiple investors are willing to pay. The numbers are deceiving, however.
Of the $40 billion in current market cap, about 55% or more derives from Asian investments. Many investors are expecting Alibaba to go public this year and Yahoo! has about a 24% interest. Yahoo! is expected to sell about 40% of its stake because of agreements with Alibaba. Yahoo! already sold about half its interest back to Alibaba for $6.3 billion in cash. The money from the sale is fueling Mayer's buying spree to acquire new Internet assets.
If Alibaba performs an IPO this year creating $125 billion in total valuation, $30 billion (75%) of Yahoo!'s current market cap is accounted for in that one investment. It should be noted that Jerry Yang may be best known as a co-founder of Yahoo!, but after making bets that include turning $1 billion into $36 billion (or maybe more) in less than 10 years, he ranks as one of the top money managers ever.
Yahoo!'s investment in Japan is worth another $5 billion, give or take a few yen. Subtract $35 billion for Asian assets from Yahoo!'s market cap of $40 billion and we can conclude Wall Street values the rest of the company near $5 billion. That's a small price to pay for the number one Internet company. Operationally, the premium after stripping out Asian assets is only about one times revenue, compared to Twitter (TWTR) at the other end of the spectrum with a price to revenue multiple of about 100. Microsoft's and Google's revenue multiples are near 4 and 8, respectively.
I'm unaware of another profitable billion-dollar company with a price to revenue multiple this brutally cheap and a single-digit price to earnings multiple. If fact, one doesn't have to push the Asian assets' valuation much higher to arrive at a price tag of zero for the core. No wonder the shares doubled in 2013, and have clear skies to continue higher.
All investors need is for Mayer to achieve a modest level of success directing the company and monetizing the latest acquisitions. If she is able to deliver, we can reasonably expect another 50% increase in share price, topping $60 within the next 24 months.
Buying at 52-week highs isn't easy for some. The fear of becoming a bag holder will keep many away, and that's why the opportunity remains. By using options, you can gain exposure and cap your downside risk.
For example, instead of buying the stock outright, sell $40 strike July Puts for about $4.25. A put gives the buyer the right but not the obligation to sell the option seller shares for $40. If the shares are trading for less than $40 at the time of option expiration, you can anticipate owning Yahoo! for $40. But you're not actually buying shares for $40 because you already received $4.25 in premium, resulting in a net cost of $35.75. To limit the downside, you can simultaneously buy a lower strike priced option and create what's known as a bull credit spread.
If the stock is closes above $40 on the third Friday in July (the expiration date), you keep the entire premium, for a gain of over 11% in about six months. If not, then you still buying at a discount compared to today's price.
At the time of publication the author had no position in any of the stocks mentioned.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.