The Best Stock in Online Advertising
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Online advertising is a very interesting business with plenty of growth opportunities in the middle and long term. It’s no secret at all that the markets for this industry are growing rapidly all over the planet, considering people spend a bigger proportion of their time in online activities, and the trend is only expected to get stronger in the following years. Online advertising is not only stealing market share from traditional media, it’s also creating new opportunities for companies which don´t fit into the old advertising methods.
Online advertising is much cheaper and better focused than TV or printed publications, so it’s a worthwhile investment for many small businesses which don´t have many reasons to use traditional advertising. Furthermore, advertisers are permanently developing new technologies to make the best possible use of the available information in order to produce more effective systems which increase the productivity of their ads.
Facebook (NASDAQ: FB) has recently launched sponsored stories, which is an advertising product based on showing the “likes” of a user to his or her friends. Companies like Amazon are already using this innovative system, and it has an intriguing potential. Friends and contacts can be considered influencers to a greater or lesser degree, so this is an interesting method to increase the relevancy of online ads.
Relevancy is precisely one of Facebook’s biggest problems, the company founded by Zuckerberg has access to a lot of information from its more than 900 million users, but it still hasn´t found a way to produce an acceptable degree of reaction to advertising. Most people have no interest in seeing ads when they log in to Facebook, so they mostly ignore the different kind of ads which are shown to them.
But online search is an entirely different story, a lot of people search specific products or services online, which makes advertising much more relevant in that context. The leader in the online search industry, Google (NASDAQ: GOOG), has managed to increase its revenues by a 29% annually over the last five years, and there is no sign of slowdown since the figure for 2011 was precisely 29.3%.
Online search is the clearest way to capitalize opportunities in online advertising, and Google is the undisputed leader in that business with a 66.7% market share in the month of May according to Comscore, followed by Microsoft (NASDAQ: MSFT) with a 15.4% and Yahoo (NASDAQ: YHOO) in third place with 13.4% of the market.
Another important advantage Google has over its competitors is an even more dominant position in mobile search. Via its Android operating system and a strong position in other platforms, Google is without question the best positioned search engine in the mobile industry, and the search business is clearly moving in that direction.
Microsoft has surpassed Yahoo as the second player in the industry over the last years, and given the fact that Yahoo uses technology powered by Microsoft, it would be fair to say that Mr Softee has earned a solid second place. But Microsoft is not a direct play on online advertising; since the company makes most of its revenues and profits from software and other businesses.
As for Yahoo, the numbers don´t look too attractive at all in comparison to Google, Yahoo has achieved lower past growth rates and has inferior growth expectations too. In terms of profitability, Google is also superior as expressed in its ROE ratio and operating margin. Both companies trade at similar valuation ratios, but Google is the market leader with much better financial performance. Unless you are expecting a dramatic turnaround in the industry, which doesn´t seem to be happening anytime soon, Google is a better possibility than Yahoo.
One interesting player is Baidu (NASDAQ: BIDU), the leading Chinese search engine is benefiting from the dispute between Google and Chinese authorities on censorship issues, and capitalizing the enormous potential of the online advertising market in China. Baidu has delivered outstanding growth rates over the last five years, and the company also has sky high profitability ratios.
Baidu carries a higher valuation than Google, but it’s not excessive considering its growth potential. The Chinese company is certainly more risky than Google though, the company is highly exposed to changing regulatory conditions in China and economic volatility in that country. Also, a scenario in which Google capitalizes its global reach to recover some of the lost ground in China sounds much more likely than Baidu eating Google´s lunch outside of its home country.
Search is definitely the best way to bet on online advertising based on the current state of the industry, and for a leading company with strong fundamentals and a reasonable valuation there is no better candidate than Google. The company could face some bumps in the road since its venturing into new and uncertain businesses like hardware, but over the long term it should be able to deliver some above average returns for its investors.
acardenal owns shares of Google. The Motley Fool owns shares of Baidu, Facebook, Google, and Microsoft. Motley Fool newsletter services recommend Baidu, Google, Microsoft, and Yahoo!. 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.If you have questions about this post or the Fool’s blog network, click here for information.