4 Leading Search Engine Stocks: Which Fit Your Portfolio?

Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Today I am going to take a look at four of the world's leading web hosting and search engine companies to see what opportunities they present for investors. In this day and age, companies supplying these services also tend to offer many more services than just web hosting and searching. Hence, there may be hidden investing opportunities here. In this article, I will focus on Google (NASDAQ: GOOG)Yahoo! (NASDAQ: YHOO)AOL (NYSE: AOL) and Sohu (NASDAQ: SOHU). I chose these four companies because I believe they best represent the diversity of the search engine industry.

Overall, Google had a disappointing third quarter. Yet the more I look at the company's report, the less disappointed I become. Third quarter results included revenues up 45% to $14.1 billion, but profits dried up by 22% to $6.53 per share. The culprit was narrowing margins, and blame can be placed on lowered ad click revenue, with a 15% average price drop, along with greatly increased costs. The cost issue is a combination of Google's Motorola purchase, along with its efforts to get into the hardware industry with its line of laptops.

I view Google's problems as a very temporary set of issues. Google management sees cell phone monitization rising three fold this year from last year, to $8 billion. Certainly, focus can be made on squeezing costs out of the Motorola purchase. I look for earnings, if not to match the last five years' average growth of 37%, to at least advance in the mid-teens going forward, giving Google a PEG of just over 1.0.

The stock price has fallen nearly 15% since third quarter earnings were released, and I look at this as a buying opportunity on this technology leader. Google has an impeccable balance sheet with long-term debt about 4% of capitalization, but it does not pay a dividend. For that reason, Google is not suitable for all investors, but for those not needing current income, Google is a winner.

Looking ahead, Google is making headway in its bout against Apple through its Google Play stores. According to a recent article from Forbes,

"In the inaugural study released by app analytics firm, App Annie Intelligence, data shows that, worldwide, the Apple store is seeing revenues four times larger than the Google Play store, but isn't growing at an impressive rate - in fact, the year-to-date growth actually is greater for the Google Play store at 311% compared to iOS at 12.9% in 2012."

Additionally, Apple only beat out Google on free app downloads by a slim margin. But looking at free app download growth rates, downloads for Android apps grew 48% so far in 2012, compared to growth of 3.3% for the iOS.

Yahoo! is often perceived as an older and smaller version of Google. However, it is not as if Mayer walked into a dead company when she took over last summer. Yahoo! has over 700 million users worldwide, outstanding news, sports, and shopping sites, and vast assets scattered around the globe. What it did not have is any of the "coolness" factor that companies like Google and Oracle have.

In the interview, Mayer disclosed her goal to bridge the "coolness" gap by recruiting top tier managers, and improving employee morale. Mayer's focus is the cell phone market, and specifically, the monetization of cell phone use. I have Yahoo! mail and messenger on my smartphone, and see no reason why more effective, revenue-producing advertising could not take place.

Financially, Yahoo! sold about half its stake in Alibaba in the third quarter, resulting in an after-tax, non-recurring gain of some $2.8 billion in the third quarter. It plans to return that to shareholders though share repurchases, which, when combined with the $3 billion 2009 buyback, will retire shares outstanding in 2009 of about 1.4 billion down by about one third by 2015. Whether that is the best use of cash is debatable, as Yahoo! has been selling for over its book value. Absent that big one time boost, earnings in the third quarter for Yahoo! of $0.33 per share were still well above the $0.23 recorded in the third quarter of 2011, and full year 2012 earnings are likely to be at least 20% above 2011, even eliminating the one-time gain.

Can Yahoo! keep up this momentum going forward? Can Mayer really turn Yahoo! into "Google lite?" New energy and ideas can be a powerful combination, and analysts at Goldman Sachs have been raising their expectations for Yahoo!'s stock price to the $24 per share level, a nice premium of 26% from the recent price. This would be on top of Yahoo!'s gain of 30% since September.

Looking ahead, I think Yahoo! is in an excellent position for many investors. Its balance sheet has minuscule debt of $38.22 million, with total cash on hand of $8.41 billion. It is probably my favorite stock among the ones I am discussing today. I am not the only one with a positive outlook on Yahoo!. Just recently, billionaire James Dinan bought up 11.4 million shares of Yahoo!. Additionally, billionare David Einhorn also added shares of Yahoo! to his portfolio.

Internet pioneer AOL is back. It was acquired by Time Warner in 2001, but was spun off into an independent company again in the fourth quarter of 2009. The new AOL is nearly debt free, but that is about the only thing positive about it financially. The new AOL's earnings peaked in 2010, and have been on a generally downward path since, as have revenues. However, the company probably bottomed out in 2011 with earnings of just $0.12 per share for the year. 2012 was guaranteed to be a success, as AOL has a patent licensing agreement with Microsoft that locks in annual profits to AOL of about $0.95 per share.

Even with that licensing lift, AOL is not terribly profitable. Based upon the first three quarters of the year, earnings from operations should come in at about $145 million, or $1.55 per share. Over the longer run, AOL must find ways to increase its revenue stream.

Like many companies with sufficient cash, AOL is planning a one time dividend payment of $5.15 per share for holders of record on Dec. 5. So, if for some reason you are interested in purchasing AOL, it would be better to do it sooner rather than later. But overall, I see AOL as an uninteresting choice from its current elevated stock price.

What's in store for AOL's future? The online advertising space is getting more crowded by the day. With competitors like Facebook, Google, and Yahoo!, AOL is going to have to step up its game. The biggest problem facing AOL going forward is its ability to translate its growth strategy - which is going well- into gains. AOL's shift to become a content site is working. Both the On Network, which contains video content, and Huffington Post have been wildly successful.

Sohu is a second tier Chinese language search engine in a market dominated by Sohu's much larger competitor, Baidu. Sohu is having a dismal 2012, with earnings coming in through the first three quarters at about half the 2011 level. That is despite revenues being up about 15% year to date. The issue for Sohu is that payouts to non-controlling interests have increased over 20%, and its majority-owned Changyou.com unit is struggling mightily with monetizing its game sites. Sohu stock has been on a generally negative path for the better part of two years, and there are alternative growth stories to consider in China, including Baidu and Sina.

Sohu has its hands in web search, online video, and its web portal. In looking ahead at its search segment, Sohu has seen impressive revenue growth rates, but it still faces massive pressure from the giant Baidu. The company expects revenue from its search segment to reach $127 million in 2012, which equates to a growth rate of 102% over the previous year.

I believe all of the four stocks discussed above offer an opportunity for different types of investors. Google looks attractive for income investors, while Yahoo! looks attractive for long-term growth investors. AOL also looks attractive as a long-term investment, and investors looking at Sohu should buy in only if they are confident enough in its growth story. Otherwise, they should go with Baidu or Sina.


StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Google and Sohu.com. Motley Fool newsletter services recommend Google, Sohu.com, 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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