Google Inc (GOOG), Microsoft (MSFT), Yahoo: Search Companies Start Your Engines

The verb usage of the word Google – according to the Merriam-Webster Dictionary – is to use the tech giant’s search engine to obtain information. Now, it’s obvious that Google has an undeniable stranglehold on the search industry, but is Microsoft Corporation (NASDAQ:MSFT) finally ready to take a significantly larger piece of the pie? Microsoft’s Bing engine was launched in 2009, and has been gaining market share ever since, passing Yahoo! Inc. (NASDAQ:YHOO) in the process; it is now the second most popular search engine in the U.S.

Google Inc (GOOG)

Google Inc (NASDAQ:GOOG) continues to increase its dominant market share, now owning almost 67% of all searches. Microsoft’s Bing owns over 15.9%, while Yahoo continues to lose market share, down to around 12.2% when the latest estimates came in. AOL is in last with 1.8%.

‘Search’ is the word, it’s got groove, it’s got meaning..

Search has long been about the advertising revenues brought in by the search companies, but now social networks are competing for this same pile of potential cash. Facebook still has the dominant position in the social network sphere with 800 million active users, compared to Google Plus’s active user base of around 100 million.

In Microsoft’s effort to infringe on the search market and make it more personable the tech giant has managed to link up with Facebook Inc (NASDAQ:FB). Facebook will help improve Bing’s search results by leveraging social connections, assuming Facebook doesn’t take on the search market on its own.

If Microsoft can figure out a way to usefully integrate Facebook into its Bing search engine it will have a unique advantage over Google by being able to bring personality to search. Microsoft continues to expand its Facebook integration into its Bing search engine with the recent addition of the ability to tag friends in particular searches. The Microsoft and Facebook relationship goes back as far as 2007, when Facebook saw Microsoft take a 1.6% a stake in the social network back in 2007.

How should investors trade this situation?

In the hedge fund industry, Google has some of the more robust fund interest, but there are three are three reasons that Google may have already peaked. Google called Lone Pine Capital its top fund owner—of those we track—at the end of 3Q, with 4.9% of their 13F invested in the search company. Other top managers were Ken Fisher and Tiger Global Management.

Yahoo is struggling to find its niche as it continues to lose search market share. Yahoo trades at what appears to be a cheap P/E at 6x, but its forward P/E is 16x. Yahoo could also be helped by Yelp, but investors are unsure if the company will make a major acquisition in the near term. From a valuation standpoint, Facebook looks a bit expensive, trading at over 100x earnings, but there’s obvious growth potential. We do like Microsoft and Facebook together and believe the former is an especially strong value play, trading at a 40% discount in relation to its historical book value. It’s unlikely that Google will lose its top spot in the search game, but the tech company is relying heavily on advertising.

Surprisingly, AOL, Inc. (NYSE:AOL) might have some of the best growth prospects, even though it is a small part of the search engine market, and trades at the cheapest valuation in the industry. Broadly speaking, search companies trade in a wide range of P/E ratios, from 3x to 20x, with AOL at a mere 3x earnings. On the sell-side, the company’s EPS growth rate for the next five years is expected to be over 100% annually. AOL’s recent patent sales should also allow for share repurchases and payment of a promised special dividend.

We are very interested in what Microsoft can accomplish with Facebook and with its various products, including its new tablet and Windows 8 operating system. We believe the company already trades cheap at 15x earnings when compared to search giant Google, but we also believe that investors are not appreciating future growth, with Microsoft trading at only 8.5x forward earnings. We also appreciate Microsoft’s dividend yield of 3.5% a bit more than its peers in this space.

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