On Website Valuation

May 18th, 2010 by Chris

I think, perhaps, people in the know about websites really have a golden opportunity in current times to buy good assets for cheap.

I invest a lot in real estate, and of course in websites, and I see a lot of parallels. They are both properties that can provide almost completely passive income.

Where they differ is in price, and real estate, even today, after the crash, is far far far more expensive than a website, on an income valuation basis.

Even if you consider all investments, a website is one of the cheapest.

Now sure, some people will claim websites are cheap because there is risk. Well, where have you been the last two years if you don’t think there is risk in real estate, bonds, or equities?

Others will claim that managing a website requires time, and that is true, but how much depends largely on the type of website. A blog will languish without regular updates, and that will take time, a generic resource site though can coast on autopilot for years, earning you passive income.

A typical yield on a corporate bond might be 5%, a yield on a US Treasury bond is too low to even consider right now. A bond provides no protection from inflation, but also very low risk. A yield on a higher yielding equity can also be 5%, and that does include some protection from inflation, but the yield can also go down, so there is added risk. But you also have the chance for capital appreciation. The highest yielding equiting, REITs and MLPs and some Preferreds, might yield 10%.

A yield is how much of your initial investment you get back each year. So on $50,000 at 10% you would get $5,000 a year, at 5% just $2,500 a year.

There are also tax implications, the tax code is scheduled to change a big deal in regards to most of it so it probably isn’t worthwhile for me to give specifics, but if you’re in a higher tax bracket, in a couple years you may end up paying 44% of your dividends in taxes. It makes very little sense for investments to be the most highly taxed form of income (because then you’re just discouraging investment, which hinders job growth and business expansion) so I’m sure congress will act, but right now, that is what you’re looking at (before any state or local taxes too).

Now, with real estate. Most banks require 25% down for an investment property, and it is hard to make a profit on rent unless you’ve owned the property a long long time. So in general you break even on the rent and your profit comes from the equity you’re building as your tenants pay down your mortgage.

If your property costs $100,000 and goes up in value at 2% a year you’re gaining $2,000 a year (the first year) in additional equity. Meanwhile, if you’re on a say 30 year mortgage (at $75k) you’re also gaining equity of, on average (I don’t want to figure amortization for this example) $2,500 a year, as your tenants pay down your mortgage. Meaning your total equity gain is $4,500, or 4.5% of your total house value.

However you didn’t pay cash for the entire house, you used leverage, debt, to get it. So to calculate your true return on investment you take the equity gain vs. your downpayment or whatever you put into the property and that gives us an 18% yield. Way better than stocks or bonds.

You of course have to deal with being a landlord, which isn’t for everyone, but the potential for returns is much greater (so long as you don’t overpay in the first place, which is what so many people did during the bubble).

On the tax front, real estate acts as a tax shelter for people with lower to middle incomes, and even people in the highest tax bracket can still use it to shelter some income. So long as you don’t sell the property your tax exposure will be very limited to nothing. When eventually your loan is paid off you can even refinance and the bank will hand you a big fat check, which you can just pocket as return of capital, no tax required.

The big downside of real estate is that your money is locked up for decades, it isn’t a liquid investment.

So bonds get us 1-5%, stocks 5-10%, and our real estate example nets us 18%. What about websites?

Well, think of a website as a rental unit where you have no tenants to worry about, never have any vacancies, and where the rent is paid to you by advertisers or consumers doing shopping.

The typical valuation tossed around is two years of profits, which I find ridiculous for all but very speculative websites, unoriginal ones, ones just this side of copyright law (or breaking it), websites that have only existed for two years or less. 90% of websites you see for sale fall into this category, I don’t bother with them in general, but I suppose that valuation is fair for them.

But for legitimate unique established websites that valuation is way to cheap.

I recently bought a website for $50,000. The website should make at least $20,000 this year in profit, which is a little bit better than what the previous owner was getting but I added some content and some ad units (and will be doing more). In the end I paid about 3x yearly profits of what it was getting for him, or 2.5x what it will be getting for me. This website is a passive resource site that requires no regular updating or maintenance and that has been around for almost 10 years, with wide and varied sources of quality incoming links.

It is very easy to figure that I’m getting a yield on it of 40%, which kicks the pants off real estate and stocks. Why would my yield be so much higher? Because it is a riskier investment? If this were a bond and it was yielding 40% that would mean that most investors were predicting the bond issuer would go bankrupt within 3 years. What do you think is the chance that my website would lose 100% of it’s value in 3 years? There is hardly any one force that could remove 100% of a website’s value, even an across the board Google ban will still allow you to get traffic from MSN and Yahoo and whatnot, the website might still make money. And, since you’re buying a well established site, and assumingly not changing it a whole lot, what would be the risk of suddenly now for no apparent reason it gets a ban?

I got a good deal, and there were other bidders, who refused to pay more than 2x annual profits, they needed a 50% yield or nothing.

I regularly get offers to buy certain of my websites and they often limit themselves to this stupid metric as well, and I tell them no thanks. You have to think of opportunity cost. Suppose I own a website that makes $100,000 a year, and I’m offered $200,000 for it. Since I am not in debt and needing a bailout or otherwise am I distressed seller I have to think about what I could do with that $200,000. Leaving taxes out of it, I could invest that $200,000 in real estate and make a 20% return, but my money would be tied up in it, still, it’d be $40,000 a year in equity, and all the headaches of being a landlord. I could invest it in a bond or equity or something yielding say 5% and make $10,000 a year, completely passive, no work on my part, and some chance for capital appreciation.

Or, I can keep the website, let it yield 50% for me, and have chance for further capital appreciation.

This is not a hard decision, especially when the website in question doesn’t require regular updating (which is the case for most of my websites).

Even a dropship ecommerce business might not require more than 30 minutes of work a day, which is certainly worth maintaining a 50% yield.

I can’t explain the prices some websites sell for, my only thought it is must be a combination of distressed sellers, and of the fact that buyers need to be specialized. Anyone can buy a website, but 99% of the population doesn’t understand how to run one, so there is a knowledge barrier, and that allows investors to get a massive yield premium.

So, as I said in the beginning of this post, if you know how to do it, investing in websites is a good idea.

Oh, before I forget, on the tax front, websites are much like real estate. Assuming you have a logical business formation like an S-corp you will not need to pay medicare and social security taxes on your business income. You will also be able to depreciate the cost of your website purchase over time. The fact that the website is bound to make more money than the depreciation (which is unlikely with real estate) does mean it’ll increase your yearly tax burden, but that should be seen as a good thing, not a bad thing. The biggest difference is you’ll probably be unable to find a bank willing to finance the purchase of a website, so you can’t use leverage to goose your yield.

11 Responses to “On Website Valuation”

  1. Bryan  Says:

    Awesome post Chris. I also try to diversify my income streams but I’ve yet to find investments that beat established niche websites and super premium domain names assuming you are a good evaluator of value. My biggest concern at this point when getting offers is considering the future (or lack of) of the long term capital gains tax. There is a big differernce between 15% and my regular tax rate which I assume I’ll be looking at in the coming years.

  2. Daniel Clough  Says:

    Brilliant blog post Chris, I enjoyed that.

    It;s got me interested in potentially buying a website and seeing what I can do with one. I’ve been wanting to try something new for a while or find something that compliments my current sites and buying something already existing might be a good way to go about it.

    What’;s the best place to look for buying websites?

  3. Daniel Clough  Says:

    Oh, I noticed this one the other day – thoughts?

    I would be after something decent and established and would be willing to part with some decent cash.

    So, I want to avoid these idiots that create a site and try and sell it for silly money like 2 months after setting up a rubbish website lol

  4. Daniel Clough  Says:

    sorry link is http://www.bizbuysell.com/

    Some of these guys are dillusional though lol. I saw one with a gross income of 1,800 and cash flow of 1,200 and he wanted 120K for it lol

  5. senthiledp  Says:

    Thanks for the great list of sites. We are always looking for new blog sites. Because it very nice and interesting very useful for our team. I have read ways to create a good SEO. I will appreciate if you guys can post more blogs. This is good. I can forward it to my clients to stress the importance of separate pages for each store location. Thanks.

  6. Hiya  Says:

    They say my website is worth over $500, even though I just started. It is definitely a pick me upper. Maybe, I put a little more effort into my website.

  7. professional website design  Says:

    I agree with you that the big downside of real estate is that your money is locked up for decades

  8. OutsourcedMyLife  Says:

    Chris, I love your writing style and the way you look at problems and solutions! I especially liked your take on website evaluations and doing an apples to apples comparison of other investments.

    I own a portfolio of sites and all but one are ones I started and manage myself (some as old as 13 years). I’ve never sold a site since I don’t need the money and my goal is to continue to build my portfolio of passive income.

    I have the money to buy more sites and the skills to run and monetize them, but I’m not very good at finding sites for sale. It would be great to know how to find more opportunities or partner up with smart people (HINT) that would allow for a mutually beneficial opportunity.

    If you know of a way to combine my resources with someone else, please let me know!!!

  9. OutsourcedMyLife  Says:

    Hey Chris, I read this post a while ago and really enjoyed it. Well, today I read an article about a possible FaceBook IPO and a potential valuation at 50 BILLION $$!

    Well, in the article they say Facebook is expected to earn nearly $1.8 billion in revenue in 2011. Hmm, if my math is right that is about a 25 times annual multiplier at a $50 billion valuation.

    I’m very interested in your thoughts!

  10. Chris  Says:

    I think Facebook gets a “most popular site on the internet” premium.

    There has been a lot of M&A activity this August, if you follow business news as I do you would have noticed it.

    In discussing the news there is always discussion of valuations, and while we’re talking companies, not websites, they’re both growing businesses. Just today I saw a summary of recent Dell acquisitions, and the average multiple was 10x trailing revenue, not profit, gross revenue.

    So a website that did $100,000 a year would be worth a cool 1m under that valuation.

  11. Pete  Says:

    Of course, the best thing about real estate investment is that property prices only ever go up!


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