Recent valuations of some big websites have gotten me thinking -- what is a website worth?

A quick look at the valuations for Facebook and Groupon makes me wonder what people are smoking. At $50 billion, Facebook is valued at about 100 times last year's earnings, and at $15 billion, Groupon is estimated to be valued at around 70 times last year's earnings.

What does that mean to an investor? If you put in $100 and Facebook pays out all its earnings in dividends, you'll get at 1% return. Assuming a typical 3% inflation rate, you're losing 2% per year.

Of course, Facebook's earnings are growing -- currently by 100% per year, according to some estimates. So you may get a 2% return and only lose 1% this year. Yippee? There are savings accounts that perform better.

If you're confident that Facebook's earnings will continue to double each year, then paying 100 times earnings this year may not be such a bad idea. Within 5 years, you could be earning 32% (ignoring inflation). But how confident are you that Facebook will keep growing like that?

Consider MySpace. "MyWho?" you ask. Surely you remember them. Less than 5 years ago, they were king of the hill. How confident are you that Facebook won't suffer a similar fate? They may very well not, but before you fork over 100 times earnings, you'd better be pretty sure.

Groupon seems even more vulnerable to me -- less established and with more credible competition.

But enough talk about the monster sites. What about your website? You may not be able to command 100 times earnings or even 70 times earnings. But what could you expect if you were to sell today?

Let's head over to one of the big website marketplaces to get an idea. At Flippa today, I see an ad for "10 AUTOBLOGS - $3.000/MONTH GUARANTEED OR MONEY BACK". The current bid? $900. Crunching the numbers, that comes out to a whopping 0.025 times guaranteed earnings.

A little further down the page, I see "Established 5 Years Old Web Traffic Business $8000 Month Net Sales", with a current bid of $3000. That's 0.03125 times earnings. Then there's "ALREADY EARNING MONEY- $300 in January", with a current bid of $150, for 0.0417 times earnings.

Reader Comment:
Antone Roundy said:
Wow, it turns out that the situation at Groupon is far worse than I thought. They're losing millions, not making millions, and were using accounting tricks to try to hide it: http://blogs.hbr.org/cs/2011/08/groupon_doomed_by_too_much_of.html
(join the conversation below)

Those may not be typical numbers (those are just the sites listed on the homepage that contain earnings claims), but from what I've seen, sites in these kinds of marketplaces often sell for less than a year's projected earnings -- often considerably less.

Why the difference? Why are the big sites valued at 100 times earnings, and the little sites at 1/100 times earnings? (I exaggerate, but you get the point.)

First of all, the big sites deserve to be valued at a higher multiple of their earnings because they're not just websites -- they're businesses with real business plans and more potential for growth.

Second, unless the income claims for the small sites include the cost of operating them (hosting, time or money spent to maintain them, etc.), they're overstating their earnings.

Third, the income claims for the small sites may be inaccurate.

But I still think the disparity is ridiculous. In my opinion, a lot of the difference is explained by the fact that these sites and businesses are being priced by supply and demand rather than their actual value.

In other words, there's only one Facebook. And since they're the darling of the industry right now, there are a lot of people who want to own it. So they're bidding the price way up.

But there are thousands of sites getting sold through Flippa and similar markets, and they're not exactly Facebooks. The glut of sites for which there isn't high demand drives their prices down. Way down. Often to the point where you wonder why people are willing to sell rather than keep the site for its ongoing income stream.

Think about it. If 10 sites can earn $3,000 a month, even if they do need to be maintained, you could outsource their maintenance for $500 and pocket $2,500 a month. Why on earn would you sell for less than $30,000, or even more? Prices are being set based too much on supply and demand, and not enough on actual value.

In the case of small websites, this leads to underpricing. In the case of big sites, it leads to overpricing.

This is the stuff that "bubbles" are made of. People believe that real estate or the stock market is a sure way to make money, so people flock to the market and put in their money, buying at whatever the market price is (without regard to actual value). More people put more money in, and the law of supply and demand pushes prices up.

Then one day, something pulls one of the lower cards out of the house of cards, exposing how absurdly far things have gone, and it all comes crashing down.

If you get in and out at the right time, you can make a lot of money. I'm not saying you can't. But it's a zero-sum game. Somebody wins because somebody else lost.

Not all investment is zero-sum. If you invest money to build an asset that produces something of value, that investment increases the total value in the system. If, on the other hand, you invest money to buy something that you hope to sell for more later, not because anything of value is being created, but simply because its market price is increasing, the total value of all the assets in the system hasn't changed.

Well, I've drifted away from what I normally try to do on this blog, which is to give practical insight and advice. So let's see what we can pull out of all this theory.

First, if you want to sell a website, don't just build a website -- build a business. Don't just throw some content up, plaster AdSense on it, and hope it makes money. Figure out a real business plan for how it's going to produce real value and grow.

Second, if you're going to buy a website, look at how much it's going to earn and how much it's going to cost to run (in terms of money and time). Think about how you could use it as part of a real business.

So how much is a website worth? Who knows. Probably not the market price.