Buying and Selling Websites – Part 2

To recap, in the last post I asked why when S&P 500 companies are valued at 15.7 times their annual net profits, websites listed on http://www.flippa.com/ are selling for 1 times profit. My personal view on this is as follows:

S&P 500 companies are large established businesses commonly in traditional sectors (oil and gas, mining, industrials, retail, financials) and often haveĀ a high degree of earnings visibility (that is to say, based upon customer orders they have revenue guaranteed for the next 6-12 months). In addition, they often have significant market share which provides a greater level of business stability and natural defence against competition.

Websites on the other hand, especially smaller ones face a far larger degree of uncertainty in their business outlooks compared to a typical S&P 500 company. Specifically, what is the business risk for a website selling (say) an assortment of face creams and body lotions? First, the product focus is very narrow – often the case with websites as they are usually built around “micro-niches”. This means that profits are extremely vulnerable to adverse changes in the marketplace such as new and successful product launches from competitors. Second, the products for sale are often merely promoted (not-owned) by the website and this lack of product control not only reduces profit margins but also often means lower barriers to entry for potential competitors. Thirdly, the lifeblood of any internet business is traffic (visitors to the website). Traffic levels are often volatile as a result of actions by competing sites and even changes in how ranking is performed by the search engines. Finally, the length of historic trading data for websites is often as little as a few months which does not inspire much confidence when you are extrapolating profits into the future.

So the bottom line is that many websites appear to be cheap due to the relatively low “quality” of the business franchise. It is easy to think that “if I buy this website for an amount equal to its annual profit then it will pay for itself in one year’s time!” But remember that the business might not be around in 12 months time! Obviously there are some great online businesses for sale on the web but extra care and due diligence is required to seek them out.