One of the first stocks I owned was Ask Jeeves [formerly ASKJ, bought out by IAC/InterActiveCorp (IACI)] which I bought after the tech bubble collapsed. It was trading at a little over a dollar and the company was quickly growing revenues and earnings. I sold the stock too early but I still made over ten times my money in that stock, a ten bagger in Lynch speak.
Ever since then I have followed the internet search sector to see if another small player could follow a similar path as Ask Jeeves. I've followed the second tier search companies for a couple of years and frankly I don't think there is any money to be made investing in these companies (from a fundamental perspective).
The smaller companies like Looksmart (NASDAQ:LOOK), Copernic (CNIC) [formerly Mamma.com - MAMA)], Miva (MIVA) [formerly Findwhat.com - FWHT], and Local.com (NASDAQ:LOCM) are nowhere close to making a consistent profit. If you have ever used their websites you know why. They simply don't deliver relevant search results.
Internet search companies make money when users click on the sponsored links that are shown in the search results when users conduct a search on their sites. They also make money if they have an affiliate program by offering ads on other websites. If they are not able to deliver relevant search results or relevant affiliate ads they are not going to make money.
Unless the second tier internet search companies can upgrade their technology to compete with the top players like Google (NASDAQ:GOOG) and Yahoo (NASDAQ:YHOO) they are going to be stuck in their current situation. People are not going use their websites for internet search and consequently they are not going get clicks on their sponsored ads. Webmasters are also not going to use their affiliate programs on their websites because the ads that are delivered are not relevant to the content and therefore will not be clicked on.
Fundamentally, I don't see any reason to invest in the second tier internet search companies.
If these companies drop way below their intrinsic value they may be considered buyout candidates. However, I don't think bigger companies are too interested in buying companies that are consistently losing money. Also, some of these companies get mentioned as buyout candidates a few times a year so rumors of buyouts need to be taken with a grain of salt.
I think the best way to play these companies is to view them as trades. Both CNIC and LOCM have made huge jumps in the past when they announced favorable press releases. Consequently, if you are anticipating that a favorable press release is about to be released it may be worth it to grab a few shares. Also, if the stock price does make a ridiculous jump on a press release you can probably make some easy money going short. Other than that I think it's probably best to just focus on another sector.
Disclosure: I have no position in any of the companies mentioned.