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4. The Scuttlebutt Approach To Website Due Diligence

The Scuttlebutt Approach To Website Due Diligence

We 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 over at WiredInvestors.com. If you haven’t seen it yet, I’d highly recommend checking it out for some interesting thoughts on the buying and selling of websites and online businesses.

Today, we’ve asked George to dig into some of the tips and tricks he uses when it comes to due diligence. This is a tough topic – no blog post, podcast topic, or eBook is going to cover everything you need. Still, I value George’s points here and wanted to share them with you as a guest post.

Alright, over to George.

One of the most important skills that you can learn when it comes to investing your money in websites is good due diligence.

With traditional investments (stocks, real estate, etc.), performing good due diligence is often the difference between success and mediocrity.

If you’re resigned to achieving average returns, you have the option of investing in index funds and putting due diligence aside the companies included in the index are usually well known enough that there’s little room for shady accounting or fraud, and besides, if you own an index fund, you’re suitably well diversified anyways.

On the other hand, if you’re looking for superior returns and you want to invest in individual companies (particularly small cap stocks), being able to perform strong due diligence will play a large part in your success. After all, smaller listed companies sometimes use accounting tricks to boost (or lower) earnings and the smallest listed companies (e.g. penny stocks) are known for engaging in less than ideal behaviors (pump and dumps, outright fraud, etc.).

When investing in websites, due diligence is even more essential. Typically, even the smallest listed company is significantly more transparent than any website you might buy. Also, if you invest in the stock market, there are often legal protections (depending on your jurisdiction) that simply don’t exist when buying websites. On open marketplaces like Flippa, outright fraud is not uncommon (obviously going through a broker like Empire Flippers reduces this risk significantly).

Still, even Empire Flippers and other top notch brokers do not give you the same kind of protections that a stock exchange would (for example, publicly listed stocks will often go through months of scrutiny and due diligence pre-IPO).

There are many lessons that website investors can learn from successful traditional investors, and how to perform good due diligence is one of them. Today, we’re going to take a due diligence lesson from the great Phil Fisher, and see how we can apply his due diligence ideas to investing in websites.

Introducing the Scuttlebutt Method

The term “scuttlebutt” admittedly sounds a bit silly, but it is one of the foundations that many great investors rely on.

Warren Buffett provides an excellent quote that introduces the idea of scuttlebutt:

“I did a lot of work in the earlier years just getting familiar with businesses and the way I would do that is use what Phil Fisher would call, the ‘Scuttlebutt Approach.’ I would go out and talk to customers, suppliers, and maybe ex-employees in some cases. Everybody.”

In stock terms, using the scuttlebutt approach basically involves performing extensive research into a company talking to suppliers, customers, and just everyday people to find out if the company has brand recognition and if its products are well regarded. Other research methods might involve visiting factories, channel checking, testing the products, or reaching out to a company’s customer service.

While many of these methods aren’t necessarily directly applicable to website investing, we can take the core philosophies behind the scuttlebutt methodology and apply them to web properties.

Regardless of the business model, websites are essentially made up of four main components:

• Traffic
• Content
• Domain
• Monetization

Now, some of these components overlap a bit, but these four components are essentially the “moving parts” of any website. If you want to utilize the scuttlebutt methodology, then your goal should be to discover as much information as possible about each aspect. In this post, we’re going to introduce a few scuttlebutt techniques that can be used to verify the various sources of traffic.

Traffic

Imagine you’re thinking about buying the stock of a retailer. One check that you might want to perform is to visit a few of its stores and find out how busy they are. If you sit opposite the flagship store of a retailer all day and you don’t see anybody going into the store, then that would be a cause for concern.

Web traffic can be treated in a similar way. Your goal is to find out:

• Where the traffic comes from
• Whether the traffic is high quality or low quality
• If the traffic is sustainable
• Whether the traffic is well diversified

Organic

If a site generates most of its traffic organically, the first thing that you want to check is what keywords (KWs) it actually ranks for. I can’t tell you the number of times that I’ve checked a website listing that claims five figures per month in organic traffic, only to discover that the site ranks for no keywords.

The straightforward way to do this is to use SEMRush. They allow for a few free checks a day, and although you don’t get access to all of the data when using the free version, knowing the main KWs that drive traffic to a site can help you establish a baseline of what you might expect organic traffic to be (and can help you work out if the claimed traffic numbers are unrealistic).

For example, if a site claims to get 50K organic visitors a month, and the best KW that it ranks on the 1st page for is a 500 LMS (Local Monthly Search) KW, that might warrant some suspicion about the reported traffic numbers.

An example from Flippa: There is a large inconsistency between seller claims and SEMRush data. Even if this site got 100% of the traffic for all of its KWs, it wouldn’t come up to nearly that much organic traffic.

Keep in mind that SEMRush isn’t always totally accurate, but if there’s a large discrepancy between what the seller claims and what shows up in the tool, then it’s probably wise to ask for Google Webmaster Tools access in addition to the standard Google Analytics (so you can check KW rankings and clicks on each KW). If you spot that a site is getting 5,000 clicks a month on a KW that the site ranks on the second page for, or for a KW that only has 100 LMS a month, then it’s possible that:

1. A) The KW is getting much more traffic than the tools are reporting.
2. B) The seller is using software to drive fake traffic to the site

In either case, you’ve found an inconsistency worth exploring.

Another check that you should perform with regards to organic traffic is the On-Page Search Engine Optimization (SEO) (this overlaps somewhat with the content aspect of a site). Overdoing on-page optimization can sometimes help rankings in the short term, but in the long term it may invite a Google penalty that could take months to recover from. Keyword stuffing in this manner is relatively uncommon these days, but it’s still worth checking for the pages on a site that receive the most organic traffic. Here’s a quick primer on how to perform great On-Page SEO.

There are checks to be made for off-page SEO as well, but we’ll go over these in a future article that covers due diligence on a website’s domain.

Organic traffic can also vary greatly in terms of quality of visitor. There are two things to keep in mind; the first is visitor intent. An ecommerce site that gets visitors who are looking to buy something will convert far better than an ecommerce site which mainly gets traffic through an information blog post that ranks for a non-buying KW.

Example:

Site A and Site B both sell socks. Site A ranks for “buy cool socks” and gets 1K visitors a month from this KW. Site B ranks for “how to wash socks” and gets 1K visitors a month. Clearly, Site A’s quality of visitor is higher from an eCommerce perspective (because it’s directly targeted at a conversion goal).

Another thing to take into account is where the visitors are coming from. It’s just a reality that average incomes in the US are higher than average incomes in some other countries (India, for example), and so on sites that are not specifically targeted at either country, a visitor from the US will be worth more (on average) to a site than a visitor from India. This is important to take into account because occasionally you’ll see sites that get large amounts of traffic from developing countries (India, Brazil, etc.) where traffic is less valuable. This doesn’t necessarily mean that the site isn’t worth buying, but you should know in advance that the potential visitor values of a site like that will be lower than an equivalent site that gets traffic from developed countries like the US, UK, Australia, etc. If you’re looking to buy this site for some strategic objective (cross-selling, customer list, etc.) this may be of particular importance.

Social Traffic

There are a number of different social platforms that can drive traffic, and it’d take up too much space to discuss each platform in detail. There are a few basic checks that you should perform to make sure that the social traffic is genuine.

The first is that you should scope out the followers/likers on each platform. Go through a few profiles of the site’s followers to see if they are real people or if they’re just fake profiles. You can also determine the quality of followers based on where they live.

An example of what is probably a fake profile. Low number of friends, a celebrity stock photo as a profile image, and the name sounds like something pulled from a random generator.

Another thing to take note of is how active the social pages are. If a site supposedly generates a ton of traffic from Facebook, then you’d expect the page to be pretty active with comments, likes, and shares. The same thing applies to Twitter and RTs as well as Pinterest and Repins. (Note: I’ve yet to see a site that drives a lot of traffic via Twitter; it’s a relatively sticky platform). You can actually check for fake Twitter followers on TwitterAudit.com.

You’ll also want to check that the seller isn’t running paid campaigns and claiming them as organic. One way to do this is to like their FB page and see how often posts come up. Organically, Facebook will rarely allow the same page to show up in your feed several times unless the page gets a ton of engagement (shares, likes, etc). If a page on FB consistently has posts showing up on your feed even though the page itself isn’t very active, it’s likely that they’re paying to boost their posts. I imagine that the same principle could apply to Twitter, Pinterest, and other social networks, but I’m less familiar with them and can’t speak to this.

Additionally, you want to be aware of the difference between viral traffic and sustainable social traffic. A site may have gotten a boost in traffic from a Reddit post, a FB post, or similar, but this traffic is not sustainable in the long term, and there’s no guarantee you can reproduce this kind of viral effect. If you see a spike upwards in Google Analytics, I’d recommend that you disregard the spike as an outlier.

Email List

I believe strongly that a targeted subscriber list is the highest quality source of traffic that’s out there. That being said, not all email lists are created equal. If a site claims to generate a large amount of email list traffic (this will show up as referral/direct if not set up properly), then you need to make sure that the email list is indeed sending this amount of traffic to the site.

Email lists are one of the few forms of traffic that you can’t independently look into. You should ask the seller for details of his past five emails to subscribers, along with relevant data such as the number of recipients, opens, clicks, and unsubscribes. Also try to find out how often the seller sends emails.

I’d also recommend that you subscribe to the list and see firsthand what kind of content subscribers receive and how frequently they get emailed. You’ll also get to see if the site has an autoresponder set up and whether or not the autoresponder works as a funnel to goal conversion.

Paid Traffic

Paid traffic can be tricky to do due diligence for in one person’s hands, a site may be profitable with paid traffic, but there’s no guarantee that you can reproduce this profitability. Even if the seller demonstrates how to run a profitable paid traffic campaign to you, a big part of running paid traffic campaigns is knowing how to adapt to changing market conditions, and this expertise comes with practice and experimentation. It’s not something you can pick up over a one-hour call with the seller.

The basic way to check whether paid traffic actually makes money is to do that math backwards.

Example:

A site gets $10 per conversion, and 2% of visitors convert on the goal. A site needs to pay less than $0.20 per visitor to be profitable.

Try and get access to granular pay-per-click (PPC) campaign data to see exactly how a campaign is being run. Typically if a seller has made money via PPC, he or she will be hesitant to share the exact details with you (because if they did, there’s a possibility that you could just recreate the site). If possible, you should request the details with some key information blacked out e.g, if a site has a profitable Adwords campaign, you might want to know the number of KWs in the campaign and their respective cost-per-clicks (CPCs), but the KWs would be partially or totally blacked out.

That being said, I’d advise people without a solid PPC skillset to stay away from sites that derive most of their traffic from paid campaigns.

Direct/Referral Traffic

Large amounts of direct/referral traffic are a big red flag unless:

• The site is high quality with a reasonably strong brand name in its niche
• The site has a large email list but hasn’t set up email tracking properly
• In the case of referral, the site has been linked to from a site that gets a ton of traffic (and the page with the link is ranking in Google)

If a site gets a ton of direct traffic that the seller claims is because of strong branding, you can confirm this by using good old Google.

Have you ever typed in the name of a site into your browser bar and left out the .com or just searched it in Google for reasons unknown? Well, this weird habit that people have can be used to your advantage. If a site claims that they have a strong brand, then there should be branded searches in Google with significant search volume. For example, Empire Flippers is definitely a known brand when it comes to website brokers. So it’s no surprise that Empire Flippers gets a reasonable amount of branded searches each month.

So, if a site claims to get direct traffic due to the strength of the brand, then it follows that there’ll be a significant amount of branded searches in Google for the site.

Compare the branded searches we found for Empire Flippers to the branded searches we see on this listing. The seller claims 50K+ per month in Direct Traffic, and yet there is zero branded search volume.

With regards to referral traffic, you should ask where the referrals are coming from.

For example, it makes sense that a site like The Reformed Broker gets referral traffic from this post because the post ranks for “best investing blog.”

On the other hand, I wouldn’t trust a site that gets referral traffic from a post/page that seems to have no traction in the search engine results (SERPs) or on social media.

Traffic that comes from a reputable website is more believable than traffic that comes from a random, unknown site. For example, I’d be more inclined to believe that significant traffic came from a Huffington Post or Buzzfeed link than a site that you’ve never heard of.

Summary

Traffic should be the starting point in any due diligence process because if the traffic data is unreliable, then everything else more or less goes out the window. Staying vigilant and going the extra mile with regards to doing due diligence on traffic will significantly reduce the likelihood of you being hoodwinked by unscrupulous sellers.

So far, we’ve introduced the scuttlebutt approach and gone over how it can be applied to website traffic. In a future installment, we’ll go over the remaining three components that make up a website (Content, Domain, and Monetization).

If you’re interested in learning more about due diligence, check out my Interactive Two-Part Due Diligence Guide. The first two installments go over some basic due diligence techniques that I apply to every site that I look at. If you’re looking to learn more advanced due diligence techniques, stay tuned! New installments of the guide will be published in the very near future.