Justin Cooke

July 28, 2015

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?”

and

“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.

dry investment climate

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.

investment risk

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.


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Discussion
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  1. […] on a website before you start looking, but you also need to consider whether it will offer you a good return on your investment of time spent working and maintaining […]

  2. Chris says:

    If anything, the comments convinced me that George Do is worth reading. ;-)

    Anyone who thinks real estate is a “piece of cake” almost certainly hasn’t owned investment property. Sure, you can hire a management company, but that doesn’t address repairs, occupancy rates, financing and many other things. It’s hardly passive income unless you’re investing through a REIT or something similar.

    The effective returns from RE are higher that stated due to tax benefits which don’t apply to buying/selling website properties. The real value to web properties is the ability to increase MRR much faster than rental income can increase.

    Both can be great investments and digital assets will definitely become better known over the next 5-10 years. However, the valuations will remain low compared to stocks until (a) performance is more transparent and (b) it becomes relatively easy to hire a digital property management company. You need to have a solid team or an extensive amount of experience in many areas to effectively buy/grow website businesses.

    ~ Chris

    • McSpike says:

      Don’t remember how I came across this old thread, but Chris, yes, I owned commercial RE that I rented. Everything was put in a contract. Apart from initial renovation I more or less didn’t do anything and whatever I had to deal with was common sense that didn’t require some special skills or knowledge. Pure an simple.

      As you put it:
      “You need to have a solid team or an extensive amount of experience in many areas to effectively buy/grow website businesses.”

      And that’s the big difference between managing a RE and managing a website.

      Prices for website management compared to prices for RE management tell the same story. They almost are as far apart as multiples.

      And that is for a good reason.

      I do agree with Justin’s last post, though. It totally depends which side of the fence you are at.

      And Chris, now a year later Justin could tell you a thing or two about how easy it is to run the 800k website portfolio that he announced in his last post here and then compare that to RE again – RE is a piece of cake compared to websites and valuations, risk and ROI are in line with that.

  3. […] had such a great response from George’s last post on the “Rise Of The Digital Asset Class” that we’ve asked him back again. George Do is a website investor and the principal blogger […]

  4. Ben says:

    Would love to see you guys do a podcast or blog post on using retirement funds to buy web sites as an investment. I think this is an option that a lot of people have and don’t really know they have it.

  5. George Do says:

    Hi,

    First off, this is a really interesting discussion and I want to thank you for taking the time to reply to me continually =)

    1. I would also like to see the type of analysis that you talk about. I think brokers probably have some idea of the % of hits versus misses, but for obvious reasons this data is probably confidential/proprietary.

    2. When I say they are grossly undervalued, I’m talking about on average. I’m definitely not saying that each and every website is undervalued. In the marketplace, some are overvalued, some are undervalued, and some are priced fairly, but I believe on average, they are undervalued.

    So for example, if I could buy each and every website that goes on sale except for the obvious scams, I believe in the long run that I would do better than if I bought each and every stock listed in the US (outside of penny stocks/obvious scams).

    I’m also a website builder =p .

    Saying that websites on average are undervalued is not the same thing as saying prices should be higher across the board – it means that prices should be higher on AVERAGE – meaning that there are some sites that are undervalued, some sites that are overvalued, but on AVERAGE a site is more likely to be undervalued than overvalued. This does not take away from the importance of doing good due diligence and valuation work on a specific website – in the same way, you might believe a real estate to be ‘cheap’ at a certain point in time on average, but that doesn’t mean that you start buying real estate without inspecting the properties in depth.

    BTW, I’m pretty sure we are already in the next dot com bubble. No clue when it will burst, but it will at some point.

    • Justin Cooke says:

      Hey guys,

      Great discussion you’re having! I just wanted to step in and answer some questions, add a few points, etc.

      1. Brokers don’t have great statistics on hits/misses. It’s not just us – that’s the case with the other brokers that we speak to and work with as well. Sure, we get anecdotal feedback from buyers on sites that do well or do poorly, but it’s not statistically significant and not really enough info to make any determinations either way.

      We’re looking to change that, though. We have a pool of investors that (by the end of the week) will have around $800K for us to use to purchase a portfolio. We’ll be tracking that portfolio over time, making changes to the sites, improvements, etc. We’ll know over the next couple of years exactly how well those sites perform. It doesn’t speak to the ENTIRE market, but will be a good/representative sample of at least a portion of sites that we’ve personally selected. Better than nothing, right?

      I can also say that (for us) nearly half of our buyers are repeat buyers over the last several years. That doesn’t say much, other than the fact that I doubt they’d keep coming back if things across the board were doing poorly. There are quite a few newbies getting into the game but many, many deals are actually done by industry insiders and professional buyers/sellers.

      2. Most investors would probably not switch from buyers/growers to building-from-scratch. They have to put their time/money into projects that will move the needle and building sites from scratch is a hit-and-miss process that is pretty slow-going out of the gate. (typically)

      3. This is a double-sided market, so there isn’t a “It works this way for most of the people, most of the time” kind of position to take. As passionate buyers argue you should be buying right now, sellers think they are unbelievably out of their minds and you should be SELLING. Those in the business on both sides of the aisle (at various points) know it’s not so black and white. You look for the best deals (for YOU) where you can buy/sell .

  6. McSpike says:

    George, what I do agree is that some very specific properties could be valued higher, but not all of them as a rule. Far from that.

    What I would really want to see now that brokers are coming up with all sorts of analysis is for them to come up with an analysis of how many websites’ metrics went south a year or two after acquisition. A large enough sample of that would put things into perspective.

    When I was talking about turning tables I was saying how things can easily be put into perspective, if sellers become buyers. How quickly they start valuing their properties properly. When they are on the selling side they apply a multiple of 10 to their baby websites without much thought put to it. If the tables get turned and they ever become buyers then the risk gets properly assessed and the multiple starts to paint a more realistic picture and is not grossly overvalued anymore.

    I am looking from a perspective of a website builder. I’ve had the chance to experience things while you may have not since you are coming from the finance sector. On the surface it may look as this is the next best thing and while that may be true for some deals it is less so for others and that others are priced just fine. Which means we can increase prices for some specific models, just not for all of them.

    If you start pricing all of them higher as a rule (assuming they are all grossly undervalued), disregarding the model, then it would make more sense for investors to start producing websites and dumping them a year later to beginner investors just because the margin would be so unbelievably high. I would no longer be buying websites, but would jump on the bandwagon of inflating the next mini dotcom bubble. Hey, it’s been 15 years, maybe we can do it again. With that in mind bring on the funds to discover this market and let’s start pumping and dumping. It would be a beautiful thing. I am sure brokers wouldn’t mind that either.

  7. George Do says:

    I’ll reply:

    1. I see what you’re saying – you’re saying you can invest less than 100K (maybe 80K or 60K or something) and get a 50K a year site in 2 years. In this case, whether or not buying is worth it to you is, as you say, a time vs money thing, and it also depends on where your skillset lies.

    Also, as you say – most people don’t necessarily have the skills to put together a site like that in 2 years. More importantly, it basically depends on how much the dollar figure is for each person individually to replicate a profitable site. For you it may be really low – $20K or less – but for someone with less experience and only versed in the basics, it may be $80K. This will change the calculation for each person.

    2. I truly believe that on average, digital assets are grossly undervalued. Here’s what I mean with this statement:

    If you were to put 1000 hours into getting GOOD at investing in any type of asset, I believe right now, the asset that you would want to choose is websites. e.g for an individual investor, putting time into learning how to invest in stocks, bonds, real estate, commodities, wines, etc. will yield less results than putting time into learning how to invest in websites. That doesn’t mean that websites aren’t risky – just that, on average, the same amount of effort and time will yield better investment returns with websites than other assets (and thus on average, they are undervalued). Yes, I believe that on average, they should be priced higher, and I believe we will see this happen, especially if big time investment funds start taking notice of this little corner of the internet.

    I don’t define due diligence the same way as you, but that’s just semantics I guess. I also don’t believe in outsourcing due diligence (or valuation) to Centurica or anyone else. As for your comment about the model of the website, I agree – let’s call this part of the valuation process rather than due diligence to avoid the dumb argument over semantics. I believe that if you arm yourself with the right knowledge, you can mitigate (but not erase completely) the risk of buying a site that will die/decline significantly within two years. While there may be a bunch of inexperienced folks out there buying up 100k sites without taking the time to learn what they’re doing first, I don’t know any of them. All the guy I’ve talked to who are buying sites in the high 5 low 6 figure ranges are experience online entrepreneurs. Also, on my site, I also recommend people start with something smaller (much smaller – e.g 5k or below) so that they can get a feel for what managing a web property is like before getting into larger acquisitions.

    You lost me when you started talking about sellers and tables turning and what not so I’ll move on.

    3. Earlier you stated that investing in websites was significantly more difficult than real estate where its easy and you don’t need to do jack.

    Then in the last post, you stated this:

    “As with anything that you dive into. After a while you know all the contractors you need to know, just as with investing in digital assets where after a while you surround yourself with developers, content producers and VAs.”

    I guess we don’t disagree that much – I don’t believe managing websites and real estate are all that different in terms of difficulty (although they certainly require a different set of skills). As you’ve mentioned – with real estate,once you figure everything out and know all the right people, and what to do in certain situations, then it becomes easier – but I would argue (and it seems you’ve inadvertently made the same point) that websites are the same way – at the start, everything is new and the entire thing is a whole learning process, but after a while you have a network of VAs, writers, webdevs etc and the management part becomes much smoother.

    Essentially, it seems you think that both Real Estate and Websites are easy, and I think both are pretty difficult.

    BTW, would love to have your problem of ‘excess money’ – if you’re ever not sure what to do with it, just email me and I’ll happy get rid of any excess money that you have trouble with =p.

    As to your last point – I agree that doing the website thing is definitively more fun than real estate – mainly because the people I get to interact with are more my speed (I’m a youngish, ‘child of the internet’ type guy, and I really don’t have any idea what I would say to a plumber or electrician – people with real life practical skills are very intimidating to me =p)

  8. McSpike says:

    Had to chime in…

    I don’t see anyone (or I may have missed it) talking about the barrier to entry. How much resources do I need to put in to replicate what you as a seller did to get to the same level? If you have a site that makes you 50k net a year and you are selling it to me for 100k the single most important question is “can I replicate that for less than 100k in a reasonable amount of time or not?”. Most of the time the cost of replicating is a lot lower than 100k. A lot. Why are we even buying it for 100k then? That is the real question. Because we have money to spend and we want to speed up investment cycle. That’s why. It’s the time we are buying here. Another thing is also the model. We are buying a model that is up and running. We don’t have to waste time to reinvent the wheel. We jump right into the game rather than getting there 2 years later. If you operate with liquid assets and don’t want to build it all, because it takes time to get the same result you start buying and get there faster. You have money, you can afford it. Life is short.

    If you think your property is worth a lot more than what it would go for on the market that just means you are not selling it and you more likely than not only see the good sides of the story. How many have checked past auctions (say on Flippa) ones a year or several years old that seemed a cool deal then only to find the metrics tanked a couple years later? It’s a reality check I tell you. People read all the sweet romantic stories about how online properties are the cheap goose that lays golden eggs, yet so many miss the part that briefly touches how many factors outside of their control influence the health of that goose.

    I remember a few years ago lawmakers in my country felt it’s a good idea to heavily tax Forex gains, because, hey, stories surfaced how these investors are making the easy money so it should only be fair to tax them higher for their easy gains. Apparently no one was on the losing end.

    Writer of this article defined profiles of people asking themselves the classic questions: “Why would anyone sell their profitable websites rather than just keeping/growing it themselves?”. He said these are buyers. 1st time buyers, yes. After you’ve bought a few websites you don’t ask yourself these questions anymore. Other people who ask this question are website owners that never tried to sell a website and are emotionally tied to their baby website OR ones that don’t have the guts to actually step into the market and are seeking excuses not to invest. Neither are buyers nor sellers. Just outsiders who don’t know any better.

    As far as websites, say we have a certain portfolio of websites that sell for 2x annual net. All of them sell for 2x annual. Yet the difference between them are enormous. With some a big part of the owner’s involvement isn’t counted in as cost and website’s annual net is in the lower 5 figure level. This means a bigger part of this investment if actually buying a job, not a website. No one ever paid Wallmart 50k to be able to work for 25k/year there. Right? You get that job without paying! I would therefore rather ask “why would anyone pay a seller to get his job?”. These short-sighted sellers never seem to realize that. And while brokers do, they don’t bring it up. I get that. I as a broker would do the same. It’s important buyers realize that. This is where the difference in pricing CAN be made. This is where some properties could be more expensive and others cheaper. The cheaper the properties the more this factor matters.

    Out of all the properties I had a chance to check I’ve seen small number of really quality ones that have their risk minimized to a level where I could comfortably say I would pay say 5 times their annual net because I knew if I continue working on the model I would be at the same annual net 5 years later, where the traffic portfolio is that diversified, competition is minimal because the model doesn’t come with low barrier to entry, clients/visitors are “stuck with the website” and new ones are lined up to experience what I have to offer, influence of outside factors beyond my control that can undermine the investment is minimized… That’s a 20% gain property. I’d still have to work, be there, brainstorm, follow trends, yet with a stable business model, I would pay a multiple of 5.

    Now compare that to real estate market. You don’t have to work jack s***! You put the money in and it trickles out on the other side at 9% per year . You can insure the property against natural disasters that are outside factor beyond what you can control.

    Now get back to online world. You have to work. Be there, follow all the numerous changes that happen every year to stay on top of the game, to see what’s trending, adapt, move on accordingly AND now comes the beauty of real easte vs. online properties: can you insure your online property from Google algo changes?

    Online world brings in a lot more risk than there exist in real estate market. Sure you can get away with it, but you if you take that sweet romantic stories as fact you either haven’t experienced a downfall of one of your properties or you haven’t checked what happened with properties others bought in the past. I seriously doubt you are going to find houses not standing anymore 10 years from now. If there’s a natural disaster, there’s the insurance company to fix the issue. Where do you have that in online world? It’s only a gamble that can pay off priced accordingly.

    With all that in mind you know why online properties in the 5- 7 figure level are using multiple lower than 5 (or rather 4) and why this ain’t going to change. Market may run in cycles as any other, but the median multiple will stay where it is.

    • George Do says:

      Hi,

      You make some valid points – however there are definitely some things that you said that I don’t agree with.

      1. I think you are drastically underestimating the time, effort, and expertise it takes to build a 50K a year website… If you can consistently create 50K websites in the span of 2 years, then by all means, that is absolutely what you should be doing. You’ll be a multi-millionaire pretty quickly if you can do that. But I honestly don’t think there are that many people who can.

      2. I don’t believe that my article promised a golden goose. I think I made a strong case for why serious investors should look into website investing, and I also think I highlighted the risks. If you read the content I have on my site, wiredinvestors.com, you’ll see that you can’t go a sentence or two without reading the words ‘due diligence’. The risks are real, and I don’t believe that I smoothed over them all that much.

      3. You said:

      “Now compare that to real estate market. You don’t have to work jack s***! You put the money in and it trickles out on the other side at 9% per year .”

      If you truly believe that, then I have to say that it doesn’t seem like you’ve ever invested in real estate. Between dealing with tenants, filling vacancies, finding people to fix things etc. I believe real estate is probably one of the least passive forms of investments (websites are also not all that passive). I mean, there’s a reason why real estate management companies exist – it’s because investing in rental properties is time consuming, difficult, and not all that fun for most people.

      Truth is, there is no easy way to get better than average returns in investing. Either you put the time and effort in and dedicate yourself to learning how to invest properly (in any given asset class), or you read the Boglehead’s Guide to Investing, put your money into an index fund, leave it for 30 years and be happy with your 10-15% per annum.

      I simply believe that at this juncture, putting your time and effort into learning how to invest in websites will yield greater returns than putting the same time and effort into learning how to invest in stocks, bonds, or real estate. That doesn’t mean that any of this stuff is easy.

      • McSpike says:

        I was making a general comment on website valuation except for where I expressly was referring to statements in an article.

        I’ll reply:

        1)
        Yes, I honestly believe that with less than 100k invested into a property with a model and history that boils down to multiple of 2 in the current market (which are mostly search engine traffic relying websites with some or little history) I could DEFINITELY produce 50k sites in less than 2 years. Many people cannot do that because they don’t have such resources in their pockets for starters. You can only become multi-millionaire in a few years, as you said, if you are bootstrapping and you can produce in a short period of time. And that’s not what I was saying. You have 100k to invest for example. It’s on you to figure out can you reproduce in less than 2 years and for less than 100k. Incompetence (translated to time, effort and expertise) can’t be priced in as hard work or added value. Market values same type of property the same disregarding the sweat and tears their owners put in it. Same as in real estate. I don’t want to hear how many times someone painted their house from ground up to get it right. One can’t price in ones lack of knowledge (which translates to time, effort & expertise). This is where sellers start to value their properties too high. They get emotionally tied to them for the wrong reasons. The value of a website consists of a base and a multiple. Base consists of the net and multiple is based on sustainability vs. replicability of the model.

        2)
        It’s not a statement I read in this article although you did say: “On Average, Digital Assets Are Grossly Undervalued”. Grossly means their multiples should be substantially higher. Due diligence is just a trivial step you take to see all the facts presented are real. If you don’t know what you are doing you can hire Centurica for that. They are not alpha and omega of due diligence (after all they have no competition) but for beginners they will be a very valuable help. They cost a grand or so, but at 100k that’s negligible. Where the real risk is hidden is in the model of the website. How sustainable it really is? Yes, the earnings paint a sweet picture now, but will they be there 2 years from now (or more, if multiple is higher)? Will the traffic that brings money to the table be there still and can you do anything about it or not and even further how much more will it really cost you to keep it at this level. Many website owners can say “I wouldn’t sell my golden goose for 2 year profit” but in reality they know they can’t really tell whether their golden goose will still be in this shape 2 years from now. It sure is well and fine now and with a hands-off approach for example it seems selling is the least smart thing to do. If they don’t need to sell, they shouldn’t. Why would they. It doesn’t really cost them a thing and it brings money to the table now. But… I wonder how they would really comment, if the tables were turned. Most don’t have the guts to turn tables, because their goose is still alive, though. If they would, they would find dozens of things that could kill their goose. That would be called reality check and proper risk assessment that romantic stories lack.

        3)
        Actually, before I decided I will invest in digital assets I was investing excess money in real estate. Money I made by being a website builder for the last 15 years. But then I figured how 10% is just silly while in am in my creative years. Real estate really is peace of cake if you do your homework first. As with anything that you dive into. After a while you know all the contractors you need to know, just as with investing in digital assets where after a while you surround yourself with developers, content producers and VAs. Also it doesn’t hurt, if you’ve been a builder yourself. If 9% is standard in your market then unless you are greedy or you don’t know what you are doing you really don’t have much to do. Money goes in, money comes out. Been there done that and it’s no fun for a man in my years. Maybe again 20 years down the road or later on to diversify, if excess money becomes a problem again.

        I agree with your last sentence. It ain’t easy, but it sure is more fun than real estate if you know what you are doing.

  9. Pete says:

    Hey guys, interesting article. As a professional investor in public stocks/bonds for an institutional fund, and also someone who has had experience with web properties, I thought I’d chime in here.

    First, the positives. No question that for someone who knows what they are doing, websites could be a great investment option. The risk/reward is favorable, and the location independence is great.

    However, comparing buying websites to stocks/bonds isn’t a fair one at ALL. Let’s go through a few reasons why:

    1) The value of any property is the present value of all of its future cash flows. For most public companies, the MAJORITY of the present value is based on something called the terminal value, which is the value of the cash flows beyond the projection period (let’s say 5-10 years). The author mentioned this as a caveat, but I really think this deserves more airtime. Buying an amazon site or adwords site at 2x annual profits is NOT the same as buying Microsoft or Procter & Gamble at 15x annual profits. I am willing to bet my retirement money that P&G will still be around in 5-10 years, and likely earning something similar to what it is today. Are you prepared to make that same claim for a $30k amazon affiliate site?

    2) Management. As another commenter suggested above, the reason you are paying higher multiples is because you have professional management teams running these companies. If you buy and never look at a stock/bond again, it will continue running exactly as it was before. What would happen to your amazon/adwords site if you left it alone for 3 months and didn’t work on it at all? I’d imagine not good things.

    3) Liquidity/friction costs. If i invest in a large-cap public security today, and change my mind tomorrow, there is a very good chance that I can exit it at a very similar price. Liquidity is HUGE for attracting a larger investor base, as it allows people to change their mind. For websites? Not only is there no guarantee of liquidity, but the friction costs of exiting are very high. If i buy a website today, and decide to sell a month from now, I’m losing 10-15% of my principal investment JUST from the transaction costs. For a stock? Depending on investment size, the friction costs are less than a tenth of a percent. Again, not comparable

    4) Valuations. Let’s be clear. While 15x PE is the average multiple, you can buy a LOT of public companies for much less than that. My day job is as a value investor, and I can pick up large cap public companies run by professional management teams for less than 10x PE

    5) Industry risk. Following up on the point above, let’s not discount the business risk here. What type of moat does your amazon or adwords site have vs. a $5-10bn public company? If someone decided they wanted to enter your space and was prepared to spend money, could you really defend yourself against them? For most public companies of any size, I would argue “yes”, simply because the investment required for any competitor is large enough to discourage them. For a sub $50k website? Not so much.

    To further prove the point, adtech companies in the public markets trade at a LARGE discount to the rest of the market. There are a number of them I can point to that trade for 5-7x earnings/cash flow. One of them (Perion networks, an ad tech company based in israel) trades for a negative enterprise value (you get the business for free based on the cash on balance sheet, and the market gives it no credit for its earnings stream). Again, an anomaly, but just proving that adtech companies should be trading at a discount to the rest of the market based on business/technology risk.

    Anyway, I don’t mean to rag on websites as I am actually a website investor as well, but I just want to make sure they are characterized fairly. The investor base that is putting their savings into blue-chip companies in the stock market is not the one that you’re looking for. This is for people with higher risk tolerance that want a hands on approach to managing a web property.

  10. Jim says:

    Justin,

    You didn’t account for the fact that investing in digital assets is substantially more risky than throwing all your funds into an Index S&P 500 fund. Most websites fail. That’s just a hard undeniable fact.

    I feel like you’re comparing apples to oranges because most of the sites for sale here and other places do NOT have years of revenue and profits to demonstrate. It’s fairly difficult to evaluate any business when they only provide you 3-5 months of earnings. If these assets had 3-5 years of solid earnings, then I can see arguing about them being undervalued.

    You also can’t diversify your risk as much with digital assets. You almost always have to make a substantial investment ($20k+) that you have a very high odds of losing.

    I don’t know about everyone else, but I can’t continue to make mistakes that big anymore. I’ve done it once and was financially raped more than some men lose in divorce! To impact that even more, the stocks I sold to make that investment are now worth over $400k.

    Maybe I’m just better at stock investing. I do know one thing though.

    Making ONE bad digital asset investment can financially cripple you.

    • Justin Cooke says:

      Hey Jim,

      I didn’t write the article, but thought I’d jump in here too.

      Buying websites is definitely more risky than putting your money into funds with larger, publicly traded companies. Of course it is – which is why there’s a much bigger reward when you get it right!

      I’d say the risk/reward is much smaller than angel investing in pre-revenue startups, though.

      Definitely somewhere in-between those two in terms of both risk and reward.

      While it’s true that most (not all) of the businesses we list don’t have 3-5 years of solid earnings, it’s also untrue that most only have 3-5 months of history. While that might be all we show upfront to non-depositors, most have anywhere from 9-24 months of earnings history, shown to depositors and those doing full due diligence.

      In terms of diversification – online properties have some of the BEST opportunities for diversifying against monetization, traffic, seasonality, etc. In fact, we think it’s critical to help mitigate the risk. Check out our podcast on this topic:

      http://empireflippers.com/larry/

      Jim – it sounds like these types of investments just aren’t for you. And that’s fair, but it doesn’t mean it isn’t a good fit for someone else.

    • George Do says:

      Hi Jim,

      I wrote the article – just wanted to respond to your comments:

      You’re technically right that I didn’t ‘account’ for the risk of investing in websites since I didn’t do the math on the risk side. However, I did make a point of stressing the riskiness of investing in websites numerous times in the article.

      You are totally right about index funds – using the Boglehead approach to investing in stocks is considerably less risky than buying websites. I strongly recommend the index fund approach for anyone who lacks either the time or inclination to invest properly (regardless of what asset class they’re thinking about investing in).

      I’m not sure what you mean by ‘most websites fail’, and I would dispute that it’s a “hard undeniable fact” as you say. It really depends on how you measure failure.

      I can’t speak to your point about earnings history – I think Justin addressed this already. However, I have bought a couple of sites myself that had 3-5 years of history and at least a couple of years of earnings at pretty reasonable multiples.

      You can diversify your risk to some extent with digital assets in a number of ways, but beyond that, you also have the very sensible option of diversifying your risk across asset classes – e.g 90% into Vanguard index funds and 10% into websites, or something similar. I disagree with your comment about $20K+ – two of my first investments were both in the ~$2K range and my returns thus far have been pretty good. There are opportunities at the lower end of the market – they’re just harder to find, especially here on EF where anything sub $5K tends to sell like hotcakes (never really understood that phrase, and I’m not entirely sure what hotcakes even are. But I digress).

      Haven’t been following the US market all that much, but it’s certainly run up in the past couple of years. Sorry to hear that you’ve not been successful with websites – it’s certainly tricky. People tend to be good at different things, so maybe you’re just better at investing in equities than you are at websites. There’s no shame in that – in many cases, you should stick to what works, so I don’t blame you for sticking with equities.

      On your last comment though. This was a bit surprising to me:

      “Making ONE bad digital asset investment can financially cripple you.”

      There are extremely few cases where ANY investment should financially cripple you. I don’t care if its websites, stocks, real estate, or anything else. You should never be putting so much of your money into one investment that the loss/devaluation of that investment will severely hurt you financially. It’s not sound money management.

      If you’re investing, you should almost never be all-in on anything.

      In my mind, the only time when it’s acceptable to be 100% committed is in entrepreneurship – and in that case, you’re basically ‘investing’ in yourself more than any asset.

  11. Steve says:

    As someone who has operated web businesses for years now and is now a buyer I see things very differently. I don’t see web businesses as being inexpensive especially at 30x. You can’t really compare these small internet businesses with larger asset classes and public companies. In my opinion they need to be compared with the prices of small brick and mortar businesses. These businesses normally sell for 2-3 times yearly earnings, plus inventory.

    This pricing is right in line with online businesses. However, since the risk involved is substantially higher than a brick and mortar business, I couldn’t say they are under priced.

    • Gerald says:

      Your right on target with this comment….great comparison..

    • George Do says:

      Hi Steve,

      Can’t say I have much experience buying brick and mortar businesses, but as far as I know (and feel free to correct me if I’m wrong), many brick and mortar businesses go for this cheap because they require significant owner input in terms of hours and effort.

      e.g, a convenience store owner who hires employees to work at the store, but also takes shifts/manages himself. That’s a full time job, and often these small business owners are taking minimal salary – in effect, the net profits of the business are what they take home in lieu of a market-rate salary.

      If an outsider were to buy this same business and not make any changes in terms of improving efficiency, then they’ve just bought themselves into what is basically a full time job.

      If you were to account for a reasonable salary for the ‘manager’ of this hypothetical store (e.g if you wanted to outsource/hire employees to cover all of the work that the owner does, including managerial and other roles), suddenly the business isn’t so cheap. Obviously there are exceptions to this rule, but I have known people who have looked into and bought brick and mortar businesses, and this seems to be how it works in many cases.

      Owners aren’t taking much salary but are working full time –> profits are are inflated –> multiples look lower than they actually would be if the owner/manager’s salary were fully accounted for at market rates.

      Compared to this, the time required to maintain a website is typically much lower, and it is much easier to outsource the work at low costs per hour. So in this sense, while the straight multiples of both types of businesses are comparable, I would argue that there are significant advantages to buying a website/web business that still make them ‘cheaper’ in real terms than buying mom&pop brick and mortar businesses.

      Also, there’s the obvious geographical/timezone flexibility that comes with working online that is simply impossible with brick and mortar. You can manage a website with a largely American audience from anywhere in the world (EF is an excellent example). On the other hand, if you buy Bob’s Corner store in Bettendorf Iowa, well, if you want to manage that business yourself, you’re pretty much stuck in Bettendorf (no offense to anybody in Bettendorf, I’m sure it’s lovely).

      This necessity for local knowledge and physical proximity to the business is another reason why small businesses will tend to be undervalued compared to other asset classes.

      • Steve Lampert says:

        George,

        I agree with you up to a point. Most brick and mortar businesses do require the physical presence of the owner, and if the owner was replaced by an employee the profit would go down.

        The reason I say I agree to a point is that many, if not most, online businesses can evaporate very quickly. Everything you do is basically public and can be duplicated by someone else who may even do it better. They’re subject to quick shifts of the market, the whims of Google’s algo and big guys coming in and taking over the market.

        For sure retail businesses are subject to outside market forces turning their businesses upside down like when a Walmart rolls into your small town our Home Depot wipes out your hardware store, but it’s much less likely. Online businesses are also much more complex and require expertise and knowledge in so many different areas.

        • George Do says:

          Agree on the comment about online businesses evaporating. That’s why I think beyond anything else, sustainability is something you should be looking for, especially at the more expensive end.

          A mid 4 figure site is something that might be worth taking a flyer on even if you’re not sure its sustainable, but when you get into 5 figures, especially high 5 figures and above, you should be looking for multiple streams of traffic and visitor loyalty on the traffic side, and reliable and less volatile monetization methods (e.g SAAS or ecommerce). At the very least, you should have a clear path to getting a site into a state where it’s not reliant on a specific traffic source of affiliate offer.

          Agree with you on the small business point – but on the flip side, small businesses are almost extremely difficult to scale due to high costs, lack of demand, and lack of a true competitive advantage. The right kind of web businesses are scalable.

          Online business definitely requires expertise and knowledge in a whole host of different areas, but for someone like myself who’s no good with his hands and pretty much only any good with a keyboard in front of him, it’s a godsend. Can’t imagine buying a print shop or something and having to figure out out to fix machines, change the ink etc =p.

    • Mohit says:

      Totally agree with you Steve.

  12. AJ says:

    Great content.
    I’ve started sites from scratch investing is more my speed.
    Keep me posted about investment opportunities

  13. Jason Ansley says:

    I would also recommend beginning to structure a portfolio of sites much like you would a portfolio of of another asset class such as Real Estate.

    Inexperienced investors will put all of their holdings under one company.

    Wiser investors, and those with a solid Tax Strategist on their team will have several entities that hold a few Real Estate holding/websites each.

    There are many reasons for this, taxes being only one of them.

    Disclaimer: I am not a tax strategist nor do I play one on TV. But I have one on my team! Seek legal entity and tax advice from licensed professionals only.

    • George Do says:

      Agreed Jason – on the other hand, not having this kind of setup should not deter relatively inexperienced investors (of any kind) from dipping their toes into the water.

      I see a lot of people worrying about relatively minor details like tax, etc. before they’ve even made their first dollar (regardless of whether they’re buying or building). These are the kind of details that you should worry about once you’re up and running, otherwise they just becomes mental blocks that stop you from trying stuff out.

  14. dc says:

    I definitely see both sides of this.

    I have a Paris related website that makes me about $350 a month. I have done nothing to it in years. It’s #1 for every possible keyword variation even over wiki and the Paris government site.

    I have at times been inclined to take the $5000 to $6000. The largest risk I see with my site or any site for that matter is that Google could suddenly move it down the search rankings. That would kill the income almost entirely.

    I think this is the biggest issue with the valuation of web assets. You’re dependent on outside factors which have changed over the years. Panda and Penguin updates devastated a lot of people.

    You are going on someone’s word that they didn’t do any funky link strategies and that their content is legit.

    But what if Google comes out with a Porcupine update that flips the script on things in the future? Or perhaps suddenly gives a lot more authority to sites like Wiki or Amazon which push your site down.

    That would be no fun.

    On the other side of things, there are a lot of factors which go into something climbing the rankings. With substantial websites, it’s no small feat. It would not be easy to take out the authority site starting from scratch in many cases.

    If you are an apparel manufacturer making yoga outfit and someone has a PR 6 yogawear.com with an engaging blog that is heavily followed and doing really well in Amazon, that’s obviously a hard opportunity to pass up at even 30 times monthly earnings. No brainer.

    But if you can recover all of your money in 20 months, that’s a pretty good risk to reward. The months/years after that is house money. If you spread it over multiple websites, you should be in great shape.

    • Justin Cooke says:

      Hey buddy – how have you been!

      I can see the Paris site – it’s linked to your WP username, heh. :-)

      Google updates can definitely motivate sellers (And give buyers pause) along with a ton of other things that are out of your control when it comes to profitable websites. (Getting kicked out of affiliate programs, less interest in niche, suppliers raising rates, etc.)

      Diversity’s important when you’re talking about this level of risk. It’s never safe, but the MORE safe you can make your portfolio the better – especially considering the already amazing returns you’re getting.

    • George Do says:

      Agree with Justin. Also – another thing to take into account is that there are large number of digital assets out there that don’t rely on Google for traffic.

      The ideal digital asset doesn’t rely heavily on Google or Social traffic – the most robust websites are ones that can make money from 1. Email lists and 2. Paid Traffic.

      Those two channels are entirely within a site owner’s control, and I believe that a websites that can successfully tap into either of those 2 traffic channels should be fetching premiums.

      Google updates are always a risk, but at the end of the day it comes down to knowing what you’re buying (e.g good due diligence). Someone who has reasonably good SEO knowledge should be able to spot a PBN or other non-white-hat linkbuilding techniques from a mile away.

      It’s good to keep abreast of the latest black hat SEO techniques precisely for this reason – even if you’re not using them, if you know what they are, you can recognize them and avoid falling into traps. Good due diligence is absolutely essential.

      Also, I believe that it is important to not view Google as some kind of unknowable god-like figure that acts capriciously. Most google updates are in direct response to the actions of Black Hat SEOs. If you know what these black hat types are doing, then chances are you’ll be able to predict (very roughly) what the next SEO-smashing google algo update will be.

      • Steve Lampert says:

        George, I think you are right on in every way. Sites that rely heavily on Google organic traffic have much more risk and should be priced accordingly.

        • George Do says:

          Indeed. It’s for this reason that I think anybody who’s managing a website should at the very least be familiar with what blackhats are doing, especially if you’re buying. Clean backlink profiles should be valued much higher vs link profiles with PBNs, tiered links, etc – I believe this is an inefficiency in the market that hasn’t yet been resolved. Even better if a site doesn’t have to rely on Google at all for traffic.

  15. Dan says:

    These numbers are pretty convincing! Great piece.

    • Justin Cooke says:

      Thanks, Dan!

      That’s an interesting niche you’re in. (Had a peek at your site) I have a buddy that’s started an online community for digital nomad families. (And those looking to get into it) I’d be happy to connect if you’re interested!

  16. As someone who spent a career investing, I agree that websites are seriously undervalued and have massive room to grow.

    I would never sell Financial Samurai for under 10x ANNUAL earnings or even revenue since the OP margin is so huge.

    Cash cows are golden in a low interest rate environment we have now and probably for decades!

    Best,

    Sam

    • Justin Cooke says:

      Most of the sellers that are selling larger sites/businesses ($100K+) convince themselves that selling is a strategic move, but may have more emotional decisions for leaving.

      – They’re sick of it, don’t have any love for the business any more, etc.

      – Not getting on with their partner and one is buying the other out.

      – Going through a divorce and need to split up the assets.

      Not to say that’s ALL sellers or anything, but if you’re not in a position to grow (or even run) the business any more, selling may be a better option.

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