Are Websites Undervalued? The Rise Of The Digital Asset Class
Running a two-sided marketplace, we see interesting arguments from both the buy and sell side. Consider these two questions:
“Why would anyone pay money for a website that can be built from scratch for next to nothing?”
“Why would anyone sell their profitable websites rather than just keeping/growing it themselves?”
The former is clearly a website builder—someone who can’t understand why anyone would buy when it could be built from scratch. The latter is a buyer—someone who sees the opportunity to grow/expand purchased sites and picks them up to work on them directly.
What’s left out of this equation are investors.
While investors relate more closely to website buyers, their thoughts on valuation, multiples, and ROI differs in a few key ways.
I’ve invited George Do from WiredInvestors.com over to share his thoughts on valuations and the rise of this new digital asset class.
George is a website investor himself who writes about website investing, due diligence, and earnings optimization. He was previously a trader at an investment bank, but now spends most of his time in coffee shops and (admittedly) browses reddit when he should be working.
Why Websites Are Undervalued
My guess is, if you’re reading the Empire Flippers blog, you’re already pretty familiar with the idea of buying and selling websites. So there’s no need to rehash the argument for why digital assets are worth looking into—I’m sure you’re aware of both the opportunities and potential pitfalls in buying websites.
However, I believe that many people in the online business community sometimes miss the bigger opportunity when it comes to the way they think about digital assets. The online business community, it seems, is a little spoilt in terms of ROIs. For example, it’s entirely possible for someone with a strong SEO skill set to bootstrap an SEO business on relatively little capital and be making four figures within a few short months. Doing business online allows you to avoid a lot of the upfront costs that are traditionally associated with starting a new business, and the “bootstrapping” or “lean startup” concepts are well-known in these circles.
Because successful online entrepreneurs are so used to high ROIs on their capital, I believe they also undervalue the assets they’ve built. On top of that, because so much of online business is built around efficiency and speed, many people who operate in the web marketing space seem too focused on the short term at the expense of the long view. Selling a site for $100K is more attractive than making $5K per month over the next 20 months if you’re mainly focused on the short term.
However, if you take a step back and start looking at websites as an asset class or as an investment, and if you start comparing websites to more traditional investments like stocks, bonds, or property—well, suddenly selling a $500-a-month site for $10K might not seem as attractive anymore.
The Current Investment Climate
If you’re someone who’s already familiar with money management and the larger investing world, you’ll know that the current investment environment is pretty tough. Attractive investment opportunities are few and far between—U.S. government and corporate bond yields are pretty much as low as they’ve ever been, and the U.S. stock market is currently trading at a P/E of about 20, which is not egregiously expensive, but is definitely above the historical average of 15. There are probably still pockets of good opportunities in Real Estate, but these can be difficult to pinpoint without extensive local knowledge. Property values in most places have fully recovered from the financial crisis.
If we look further afield, both emerging markets and Europe look to be on shaky ground. Many emerging markets are economically tied to China, a country with significant structural problems (and where the stock market just dropped 30% in a matter of weeks). Europe has its own problems—it’s dealing with the ongoing issues with Greece, and even if that is eventually resolved, it seems like the region will face continuing instability due to the inherent flaws of their currency system.
In this rather arid investing environment, the returns on digital assets (websites) look incredible, even when we take into account the additional risks that are inherent with buying websites.
On Average, Digital Assets Are Grossly Undervalued
Before I go into depth about why websites are undervalued, I’ll run through a few traditional asset classes to demonstrate the extent of the undervaluation that I’m talking about.
Typically, reputable, well-known website brokers (like the one whose blog you’re reading) sell sites for 20x to 35x their monthly earnings. If we take this figure and compare it to the historical P/E of the S&P 500 (about 15x annual earnings), we immediately see the huge difference between valuations. Even at the high end of website valuations, 35x would be considered extremely cheap in stock market terms. 35x monthly earnings is roughly equivalent to a P/E of 3. The sites that are sold here on EF are typically sold at about 20x-36x monthly earnings—equivalent to a PE of 1.67 to 3.00 in annual terms.
Therefore, for the same amount of earnings, digital assets are on average about 5-8 times cheaper than stocks.
Next, we move to bonds. Bond yields right now are basically at historical lows. I won’t make a comparison to government bonds, since U.S. government bonds are more or less risk free and thus aren’t a good comparison to investing in websites, which are risky. Instead, I’ll use the (rather arbitrary) 20y Single A Corporate Bond Yield* of 4.51%. So you can buy the debt of a good-but-not-great company and earn 4.51% a year on your money. If you buy a website at 20x, your return should work out to about 60% a year.
*Without going on a long diatribe, bonds rated BBB and above are considered “investment grade”, and bonds below BBB are termed “junk bonds.” Single A bonds are one level above BBB. I wanted to use BBB as it’s the lowest level of investment grade, but the single A data was much easier to find and understand.
Next, we move on to real estate. Real estate is probably the best comparison to make when thinking about websites as an asset class. While stocks and bonds are pretty much as passive as you want them to be, both real estate and websites are assets that require some level of upkeep, and in both cases, having a relevant skillset can help a lot when it comes to maintaining/improving the asset (e.g if you’re good at DIY, you can fix houses up to improve their value).
Real estate fares a little bit better than the other investment types that we’ve discussed; on average, real estate investments yield about 9%. Still, compared to the 60% that we get from a valuation of 20x monthly earnings, 9% a year doesn’t seem all that attractive.
Here is a quick table I put together to demonstrate the potential differences in returns
|Asset Class||Source||% Yield|
|U.S. Equities (S&P 500)||Wall Street Journal||P/E 20x Earnings Yield of 5%|
|20 year AA Corporate Bonds||Yahoo Finance||4.42%|
|US Real Estate||RealtyTrac||9.04%|
|Digital Assets||Empire Flippers||20x Monthly Annual Yield 60%|
The Reasons Why Digital Assets Are Cheap
First and foremost, I believe a large portion of website undervaluation stems from the fact that the mainstream investment community hasn’t caught on yet. While I’m not sure there would be enough supply to support the kind of large scale securitization that we saw with mortgages or student loans, I do believe that at some point, the financial world will spot this little pocket of value, exploit it, and push valuations up across the board. In fact, I believe this is already happening on a smaller scale—if I remember correctly, here at EF, Justin and Joe currently in the pilot stages of an investor program.
Another reason websites are undervalued is because it takes a specific skillset to buy, manage, and improve websites. For those who aren’t familiar with online business, a lot of these skills can seem daunting. (If you don’t believe me, just start talking SEO or CRO with someone who’s not in the internet business space and watch their eyes glaze over.) Because these web marketing concepts are so foreign to most people, they effectively act as a barrier to entry, in the same way that renovating an entire house seems like an impossible task to somebody like me.
On top of the skills required to run a website, you also need to learn proper due diligence—this acts as another barrier to entry for traditional investors. While the end goals behind proper due diligence for online and offline businesses are similar, the practical steps that you need to take to complete good DD on an online business are completely different than with offline businesses. Instead of doing channel checks and monitoring walk-in traffic, you’ll be looking at Google analytics and evaluating conversion rates.
There’s also inherent risk when buying a website. At the end of the day, it’s impossible to deny that buying a website is riskier than investing in other asset classes at face value. With stocks, bonds, and property, there are clear legal frameworks and investor protections in place. While there is definitely fraud in all of these markets, the % of outright scams in the website market is definitely significantly higher than what you’ll find in more traditional asset classes (particularly on marketplaces like Flippa—there are good bargains to be found there, but there are also many, many less-than-legitimate listings).
Buying websites through a good broker (like Empire Flippers) definitely helps to greatly reduce this risk. However, you should remember that you’re ultimately responsible for your own due diligence.
Also, it’s probably true that on average, websites have a shorter lifespan when compared to other asset classes. It’s easy to imagine a company like Target still being around 20 years from now, but it’s much more difficult to say the same about your fishing rod affiliate site.
So yes, on the whole, website investing is riskier than investing in more traditional asset classes. However, I don’t believe that the increased risk fully justifies the huge valuation gap. In other words, I believe that even taking into account the increased risks, websites are still significantly undervalued when compared to the broader investment universe.
Thinking about Websites as Assets
At this point, you might be thinking “Okay, so websites are cheap on average—but what’s the actual point of this article?”
Well, here it is. Websites should be considered assets or investments. This means that investors should be comparing digital assets to other assets classes to gauge their attractiveness, and they should be buying,managing, and selling their websites as if they were assets rather than commodities.
Changing your mindset in this way should lead to the following
- Your websites will have longer lifespans because you’ll prioritize preserving asset value over making quick cash (e.g you might choose not to accept those guest posts from that dodgy gambling company)
- The websites that you buy will be higher quality because you’ll spend more time on due diligence—in the same way that you spend more time doing due diligence on a stock (asset) than, say, a laundry machine (commodity)
- Selling will no longer be the default option if you’ve built up a nice, income-producing digital asset; the long-term income potential of a website will start looking more attractive than a quick flip at 20x-30x monthly earnings
- You’ll start to gravitate more towards buying and holding rather than buying and flipping
- If you have the capital, buying a site will look more attractive than building a site from scratch, in the same way that buying and renovating an existing house makes more sense as as investment than building a house from scratch (because building a site from scratch from $0K – $1K per month takes about the same amount of time/energy as buying one and taking it from $1K – $5K per month)
Take an Investor’s Approach to the Website Marketplace
I’m mainly a website buyer myself (as opposed to a seller), so my final thoughts are largely directed towards buyers, both beginners and those with more experience.
You should approach the digital asset marketplace in the same way that you would invest in an exotic, frontier market. In this hypothetical frontier market, companies are undervalued across the board, and the returns can be great. But the legal framework is flakey and the overall transparency of the market is low.
Many people would shy away from investing in this kind of market—but that’s not the correct approach. Just think about the amount of wealth generated by those who got in early at a place like China (even considering their recent stock market troubles). The correct approach is to learn the necessary due diligence skills, work out the best practices, and then invest cautiously.
You should treat websites like investments—take a long-term view, buy carefully, and sell only at the right times and for the right reasons. Chances are, you’ll do well.
Imagine you were an investor interested in investing in an exotic country. The prices of companies in this country are low, and the returns are good, but the legal system is unreliable and opaque and the accounting systems are completely different than what you’re familiar with.
That’s exactly how you should view the market for digital assets. Treat it as an entirely new investing environment, learn the best practices, familiarize yourself with the systems involved, and tread carefully. The only real difference between investing in websites and investing in an exotic frontier market is that in most frontier markets, you need special legal permissions to invest. But in the market for websites, there’s a level playing field, and everybody has access.
The market for digital assets is like the Wild West. While there are great risks involved, there is also great opportunity, but only if you proceed with discipline and caution. Those who perform recklessly will end up regretting it, but those who do it properly will be rewarded handsomely.
Learn More About Investing in Websites
Have any questions or comments? I’m happy to respond in the comments section. If you liked this post, I frequently write about buying websites from an investment perspective over at WiredInvestors.com.