The leadership vacancy arose after Mr Sharon dramatically resigned from Likud last month and announced the formation of a new centrist party called Kadima.
The 56-year-old Mr Netanyahu was formally declared the winner shortly after his closest challenger, Foreign Minister, Silvan Shalom, conceded defeat.
Mr Netanyahu pledged in his victory speech to lead the party back to power. The Likud party, which dominated Israeli politics for 30 years, is facing a possible melt down in March general elections.
“I came here tonight to tell you that as of now, the Likud is beginning the march back to reclaim the leadership of the country, he told supporters at Likud’s Tel Aviv headquarters.
Although the final official results are still to be declared an exit poll, carried jointly by public television and radio, said Mr Netanyahu secured 47 percent of votes, while his closest challenger, Mr Shalom, won 32 percent.
News of Mr Netanyahu’s victory came as Israeli Prime Minister Ariel Sharon rests in hospital after the minor stroke which has raised questions over his political future.
Doctors say however that he should recover fully.
The hefty 77-year-old Mr Sharon, battling for re-election after pulling Jewish settlers from the Gaza Strip and remaking Israel's political landscape, was rushed to hospital yesterday.
Doctors said Mr Sharon would stay for further tests and if all goes well would be discharged tomorrow, though an aide said it would take longer to return to full working capacity.
According to neurologists the blood clot on his brain went without causing any lasting damage.
"There is an excellent chance this will not repeat itself," chief neurologist Tamir Ben-Hur said.
"I think after he rests he will be able to return to normal activity," he said.
He said Mr Sharon's clot had been caused by a minor heart problem, which he said was not uncommon in otherwise healthy people.
Political ramifications
A parliamentary election is due in March and some commentators have suggested the health scare could damage the prospects of Mr Sharon's new centrist party Kadima.
"Kadima's existence depends on one man," wrote Nahum Barnea in the mass-market Yedioth Ahronoth daily.
"It is reasonable to assume that the stroke ... damaged his party in electoral terms."
Aides rushed to assure Israelis that Mr Sharon is in no danger and that there was no need for even a temporary transfer of his powers.
Mr Sharon is very much a one-man show and his exit from the scene would mean a major upheaval.
He told Israeli media overnight that he was fine. "I guess I should have taken a few days off," he said.
"There are people who are already interested in a replacement? Well, maybe it's too soon. I'm still here, no?"
Mr Sharon's role has never been more critical than after pulling settlers from the occupied strip this year and quitting his right-wing Likud party to form a new movement with a promise to pursue peacemaking with Palestinians.