investing in websites

Sep28
by TFS on September 28, 2015 at 7:21 pm
Posted In: How To, Investing, Lifestyle Design

Wired Investors

 

 

We have a guest post for you today from George at WiredInvestors. I’ve been interested in the idea of buying and monetising websites as part of the FI / side hustling strategy for a while now but haven’t had the time to research it further, let alone the balls to actually take the plunge and buy an asset class such as this! So it was with great interest when I read a guest post of George’s on such an esteemed FI website as the MadFIentist. Lo and behold a few weeks later he got in contact with me about a guest post here so I couldn’t refuse to get even more information about it all! Over to you George…

 

 

Hi TFS readers. I’m George, and I write about investing in websites on WiredInvestors. The TFS himself was kind enough to allow me a chance to guest post on the site. Today, I’m going to try and explain why (and why not) you might want to look into buying websites as a means of bolstering your income. I’ll also go over a little of my own background so you know where I’m coming from. Additionally, I’ll try to explain how website investing compares to traditional investing opportunities like stocks, bonds, and real estate.

Caveat

The first and most important thing that I want to point out before I continue is that investing in websites is pretty risky business, especially for a first timer, and as such, I do not recommend that anybody stretch themselves financially in order to buy a website. Investing in a website should be something you do when you’re already reasonably financially secure – it’s something you might want to try as a way to get more bang for your investment buck. This is not the kind of investment that you should be making if you’re not actively saving and investing already.

 

My Background

A little over a year ago, I had a cushy job as an exotic rates trader at an investment bank in Hong Kong (that’s where I’m from). My life was pretty straightforward – get to work at 8am, leave work at 7pm, grab dinner, and go to bed. This isn’t one of those stories where I left a soul-crushing, awful job in order to pursue financial independence. I actually enjoyed my job – it was challenging and I got along with my colleagues pretty well.

I guess that’s why it wasn’t until I was out of a job that I realised I was on a path that was fundamentally misaligned with what I wanted from life. From a pretty young age, I knew that I wanted:

  • To be able to live in multiple countries
  • The freedom to travel for long periods of time
  • Ability to set my own schedule for work
  • Still be able to afford the things that I love (mainly good food)

My job had definitely allowed me to lead a pretty comfortable lifestyle, but at the end of the day climbing up the corporate ladder wasn’t something that interested me all that much.

Now, don’t get me wrong – I don’t regret my time in the corporate world at all. It allowed me to save enough to be able to survive for a couple of years, especially since I decided to move to Vietnam (from Hong Kong) to take advantage of the lower cost of living. I’m not one of these anti-corporations, take-back-your-life folks. I know many people who are perfectly happy in the corporate world, and more power to them. I just know now that the lifestyle wasn’t for me.

 

So, What Next?

So, what did I do instead? I moved to Vietnam, where the living costs are low. Then I started thinking about how I could go about making a living.

After reading a ton about online business, I stumbled across the idea of buying websites for income. This seemed like the perfect opportunity for me – it gave me the ability to utilize a pre-existing skill-set (my understanding of finance and investing) and apply it to online business.

I started off small – the first site I bought was under $2000, and it was basically making no money at all. I had a hunch that if I just added a few ads to the site, based on the number of visitors the site was getting, I would be able to make at least $150 per month from ad revenue alone. My hunch was correct – the site is currently churning along at about $200 a month, and I only spend 2 or 3 hours a month updating it.

Since then I’ve bought a few other sites – one was a total failure (it was a site that went Viral that died out pretty quickly) – luckily, I only spend $600 on that site. My other investments have been pretty successful – I’ve managed to boost monetisation on each investment that I’ve made, and going forward I’m planning to scale upwards into higher quality, more expensive sites.

 

What Makes Website Investing so Interesting?

Well, it comes down to one thing. The returns have the potential to be silly. We finance folks are trained to think about the ‘investment universe’ as a whole. That means that we automatically compare the risks and average returns of different asset classes against each other.

So, how do website investments compare to these other asset classes?

Equities

Right now the S&P 500 is trading at a PE of about 20x, and the long term historical average of the index is about 15x. This translates to an earnings yield of about 5% (currently) or 6.67% (historically). The FTSE 100 is currently trading at 15.2x, and the historical average is 15x, so we can call that an earnings yield of about 6.67% as well.

Compare this to the website market. Different brokers/marketplaces will have different average multiples, but Digital Exits (a high-end broker) puts their average multiple at about 2.46x annual earnings. Empire Flippers, a broker that primarily works with smaller websites, typically prices sites at around 20x-30x monthly earnings, which translates to ‘PE’ of 1.67x to 2.5x.

Now, for a number of reasons, this comparison isn’t totally fair – and we’ll go over these reasons in detail further down in this post. But even accepting the fact that the comparison isn’t totally apples-to-apples, there is definitely a large valuation gap between the average price of equities and the average price for websites.

Bonds

I’m going to use corporate bonds in this example since (US) government bonds are generally considered risk-free and thus don’t make sense as a comparison to an obviously risky asset class like websites.

We’re living in a low yield environment, where 20y single A corporate bonds are yielding 4.3%. I was unable to find solid historical data (without subscribing to some expensive data package) on the long term average of corporate bond yields, so I’ll leave the aside.

If we take the higher average valuation from the example above, 2.46x annual earnings that translates to a yield of about 40.6% – obviously there is a large gap between the yield on an average website and corporate bond yields in the current investment climate.

Real Estate

To me, Real Estate probably makes for the fairest comparison when we’re discussing websites as an asset class. When you invest in a website, you’re essentially buying ‘virtual’ real estate, and indeed, many of the skills required for real estate investing have virtual analogues. For example, when you invest in real estate, you either need to have the DIY skills to do maintenance yourself, or you’re going to need to pay someone to take care of it for you. Similarly, if you don’t have the skills to properly manage and maintain a website, you may end up needing to outsource certain tasks to people who have the skills that you lack. In both cases, it’s probably best if you have at least some understanding of how to take care of your investment property (even if you don’t end up outsourcing the work).

Currently, real estate has gross yields about 9% in the US. This doesn’t take into account the various expenses that are associated with real estate investments (maintenance costs, property taxes, vacancies, etc.). I know most TFS readers are probably from the UK – currently, property in the UK yields about 8.9%. Compare this to the average yield of 40.6% (numbers from the higher end broker) that we discussed earlier. Again, there is a marked difference between the yield on property and the yield on websites.

Small Businesses

I’ve heard multiple times that buying websites is comparable to buying small businesses, and that the multiples (2-3x annual earnings on average) make sense in this context. There are a few reasons why I don’t think that this comparison is a good one.

In many cases, small business owners don’t pay themselves salary even though work on the businesses full time. They simply take home the profits. If we were to try and replace the current business owner’s work, the extra wage that would be paid out usually cuts into the profitability of the business significantly. This usually isn’t the case with websites – while there is definitely work that needs to be done on a website on a monthly or weekly basis, this work rarely adds up to the equivalent of a full time job. Paying someone to do the work of a small business owner will usually cut in profitability vastly more than outsourcing the work of a website owner.

Another thing to take into account is that small businesses are very much tied to their locations. There are two problems with this. Firstly, anybody who purchases a small business will be forced to be near the business most of the time in order to manage it properly. Secondly, local businesses are extremely difficult to scale, in part because one of the things that allow small businesses to do well is local brand recognition and awareness. (e.g Bob McDonald’s Auto Repair will need to start from scratch if they expand to a new area because nobody knows who Bob McDonald is in the new location).

Websites or web businesses can be managed from pretty much anywhere where you can find a wifi connection – location independence is built in. Also, scaling a web business or a website is typically easier than scaling a small local business – in fact, one of the reasons why doing business online is becoming increasingly prevalent is precisely because of the inherent scalability that’s built in to the business model.

 

Wait – What’s the Catch?

I promised that I’d discuss why the comparisons that I made above aren’t fair. It basically boils down to the following:

  1. Websites aren’t totally passive investments – you can’t ‘set it and forget it’ with website investing in the same way that you can if you’re buying into an index fund or government bonds.
  2. Websites, on average, are significantly riskier than the investment alternatives we discussed (perhaps outside of small businesses).
  3. Managing, maintaining, and improving websites takes a specific set of skills that not many people have (on the other hand, this acts as a significant barrier to entry for many investors – it’s one of the reasons websites are undervalued).
  4. The average lifespan of a typical website is somewhat lower than the average lifespan of a listed company or investment property.

I’m not here to pretend that investing in websites is a catch-all solution to your financial woes. There are very significant, real downsides to website investing.

Here’s a breakdown of some of the risks that are pretty specific to buying websites:

  • There is more or less no regulation when it comes to the website marketplace – so you’re likely to come up against both exaggerated claims of earnings or website traffic as well as outright fraud when prospecting potential investments. It’s up to you to perform your own due diligence – the website marketplace is 100% Caveat Emptor (Buyer Beware).
  • If you want to be successful with website investing, you’ll need to be willing to learn a specific set of skills that are unique to online business (e.g Search engine optimisation, basic html/css, various methods of monetisation, etc.) While you don’t need any kind of expertise, there is a definite learning curve involved with managing and improving websites.
  • The legal system does not have your back – if you get scammed, well, you’re pretty much out of luck. Many website transactions occur across borders, and even if you’ve signed a contract, there’s usually very little you can do to enforce it. Again, good due diligence is extremely important – if you’re not prepared to spend some time learning how to do due diligence for websites, then you should probably just stick to index funds.
  • Websites can sometimes get their earnings erased overnight due to changes in the web ecosystem (e.g if a site primarily gets traffic from Google and Google updates its search algorithm, the site might lose all its traffic). While there are ways that you can protect yourself against this (by diversifying your traffic sources and avoiding shady tactics), the risk is always there. Most websites also naturally have shorter lifespans than other assets – e.g I have no idea whether Buzzfeed will still be around in 15 years, but General Electric definitely will.

 

My Take on Website Valuations

Based on all of the examples above, I believe that on average websites are an undervalued asset class. Additionally, while websites are definitely riskier than many of the other investments I listed above, I also think that adjusted for risk, websites make for a better value proposition than most other asset classes. In particular, smart, careful investors should be able to take advantage of the gap in valuations while negating/minimising most of the risks – these investors will do extremely well for themselves investing in websites.

For those of you who’re familiar with the stock market, the closest comparison that I can make is small cap stocks. Historically, on average, small cap stocks have outperformed large cap stocks even when we take risk into account.

However, there is a class of investors who do even better than average when investing in small caps. For example, Warren Buffet (one of my heroes) started off primarily as a small cap investor, and he was able to take advantage of the greater returns that small cap stocks offer while avoiding many of the risk associated with investing in smaller companies – and we all know how well he’s done. He did this by focusing on the value and quality of businesses he invested in, and by going above and beyond in terms of his research and due diligence of companies.

Similarly, those investors who take the time to perform in depth due diligence and research of the websites that they buy will be able to take advantage of the valuation gap whilst mitigating most of the risks. If you think that you have the capability to be one of these investors, then it might be worth time to look further into website investing.

If this post has piqued your interest, I highly recommend that you take the time to read more about investing in websites. Also, when you do get around to buying your first site, make sure that you start small – not only will you pick up a whole new understanding of online business, you’ll also get proof-of-concept that websites are a viable option when it comes to investing your money.

 

So, how do I Get Started?

Wired Investors

Website Due Diligence Basics Part 1

Website Due Diligence Basics Part 2

Buy and Sell Websites Part 1

Buy and Sell Websites Part 2

Empire Flippers

Website Buying FAQ

SEO Tips for Website Buying

Podcast (Many relevant episodes)

Experienced People

Due Diligence Tips (A little dated, but much of the advice still applies)

Forum (If you’re willing to dig through old forum posts, there are many helpful pointers. No longer active).

SmartPassiveIncome

Podcast episode with Chris Guthrie about Website Investing

Quicksprout

Website Buying Guide

Takeaways

  • Websites are riskier than other assets
  • Websites are probably undervalued compared to other assets, even given the extra risk
  • Investing in websites has a definite learning curve that should not be ignored
  • Those who’re looking for better returns should start reading/learning more about website investing
  • Beginner investors should start small

Author Bio

George is a website investor and writes about website investing, due diligence, and earnings optimisation at WiredInvestors.com. In a past life, he was a trader at an investment bank, but nowadays he spends most of his time in coffee shops browsing reddit whilst he should be working.

 

Thanks ever so much to George for such an information packed post!

From my own point of view as someone who is fairly au fait with setting up and running websites, this sounds like a very interesting prospect to earn some extra cash as a side gig. While it’s unlikely to get anyone to FI on it’s own (unless you went hell for leather on it and put in a lot of work), I think it would be a fun little project to buy up a few websites and see what you could do with them…

I also really like George’s whole story and the fact that he moved to a lower cost of living area to achieve some more freedom in his life. I am sure that his priorities in life resonated with most of the readers here. Kudos to you George!

If you have any questions for George please leave them below!

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