Why is the rate of return for website investments so high? Are websites a good investment?

Question

Popular websites can make a lot of money through monetization channels such as ads, but when it comes to buying an existing site, why is the multiple on earnings so low? For example at the moment a site is being advertised for $25,000 with a net profit of $1,105/month.

On a 2x multiple, it would take two years to recoup the initial investment and then you would be making 50% annual return on investment which seems insane relative to the ~10% in stocks or ~7% in real estate? Are assumptions on continued monetization the real killer? What kinds of risks are not priced in, or why isn't this taught as a popular investment choice relative to real estate or stocks?

Answer 1

Because if you buy a website and just sit on it as an investment, its revenue and value will quickly collapse. You need to keep doing a lot of work to keep it current. You’re not buying an investment, you’re buying a business that you’ll be working in, and most of the return is the return on your labour, not on your original investment.

Answer 2

" What kinds of risks are not priced in, or why isn't this taught as a popular investment choice relative to real estate or stocks?"

You are thinking about the concept of rate of return vs risk backwards - the more risky an asset, the higher return it should have. Otherwise, someone would just buy a lower-risk asset instead and earn the same average return.

So if a tech company or website has a rate of return of 50% annually, then (assuming it is fairly priced), that means something along the lines of 'this is 5x riskier than a standard stock index which earns 10% annually on average'.

I have no idea if your particular example is real (are they being honest about revenues and costs?), or if it is fairly priced (maybe it is even 3x more risky than the return it already has, so it should cost 1/3 as much). But in general, you should expect a riskier asset to have higher average returns.

Use this as a warning, then - even the seller is telling you exactly how risky they think the website is - otherwise they wouldn't part with it for so little!.

Answer 3

It depends a lot on the business model of that website. Because it's a business, not just a property or an investment. Here are a few examples.

• If the site works on a subscription model, then revenues are usually quite stable, if all billing is automated. You may see churn (people stopping their subscriptions), but unless there's is something very peculiar, it shouldn't be abrupt. Even if you lose 10% of existing customers every year and don't add any new ones, it will continue to make money for quite some time. Expect such sites to have a much larger multiplier.

  Note that one significant issue here involves customers paying with a debit/credit card, as those expire, and depending on the system used, this may be take care of automatically, or require users to provide new data. If the value proposition of the site has changed significantly, they have little incentive to do that.

  Part of what you are buying is, I suppose, content, or a way to produce it, or a service provided, and the recipe to deliver it. If it's content, and the seller stopped producing any content a few months ago, then the site is living off its past production, but the content may become stale, or not interesting enough for customers to keep on paying.

  If there is content being produced or a service delivered, remember that the seller may be doing that themselves and not be counting their time to do all that in the costs, and thus in the net profit. You'll either have to do that yourself (is the profit worth the time you need to spend?) or pay someone else to do.

• If the site derives its revenue from advertising, this in turn depends on its audience (number of visitors to the site, how long they stay, where they are from, etc.). If visitors come mostly from SEO (search engine optimisation, so-called "organic" search engine visits), that can be very, very variable. If Google adjusts a knob here or there, you can jump up or down in results, and that can change your figures overnight, by orders or magnitude. This can make a site that generates a few thousand a month suddenly drop down to a few dollars.

  If the audience is based on recurring visitors, then you may have the same issue as above if it's all based on content that needs to be produced (say, a blog).

  If the audience comes from social networks, then an active presence on social networks is needed. Same issue as above. It might be worse if that relied on the social networks presence of the seller, and they don't sell that.

  If the audience comes from paid traffic, then that is usually quite stable, though Google do change their rules from time to time with little warning, and they have no qualms cutting all traffic even to advertisers paying them millions.

So like with any business, there is a risk. It may be because the revenue relies on something very unreliable like SEO. It may be because the seller does not tell you of all the costs (explicit and implicit such as time spent). It may be a ton of other reasons.

Remember that in tech, things can change very quickly. A major player (Apple, Google...) may suddenly make you site/app/whatever obsolete (they integrated the feature for free in one of their products), for instance.

Usually, the multiplier will be quite dependent on the reliability of the business. Someone selling a business with a proven, stable, and durable revenue stream will sell for a lot more than someone selling a business which can go belly-up overnight. Or at least the buyer should apply those rules!

Answer 4

My website is making 500.000$ a month and I want to ramp up the game and ill do it by buying a website with the keyword in URL, with traffic, relevance, and authority in a niche. Ill 301 it and drop a kitchen sink spam on it and gain 10.000$ increased in monthly revenue on my own site from the juice passed. If you don't know how to do domain analysis you cant assess the value of a given domain. The skillset needed is called Search Engine Optimization aka SEO. Websites are always a good investment, for an SEO expert.