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Studies & Opinions

Domain Names Are Cheap!

Alex Tajirian
June 17, 2005

 

Using data on name price-to-earning (PE) ratios for domain names, we conclude that market prices of domain names are significantly undervalued. With the emergence of a developed secondary market, domain names are ripe for acquisitions as a new investment class.

I will first provide information on PE ratios for various industry groups and domain names. I will then point out the investment implications for assets with low PE ratios.

The PE ratio is the multiple obtained by dividing the market price per share by the earnings per share over a period, which is equivalent to an assetís market value divided by its earnings.

Table 1, below, represents the PE and betas, a measure of undiversifiable risk, for a selected list of industries. Investment companies, as a group, have the overall lowest PE, while the entertainment technology group has the highest. The Market represents the weighted average of all PR ratios. The table also suggests there isnít a direct relationship between industry PE and beta. However, there is empirical evidence that lowest PE stocks are, on average, less volatile than the highest PE stocks.

Table 1. Industry PE and Beta

Industry Name

PE

Beta

Investment Co.

15.79

0.64

Securities Brokerage

24.16

1.32

E-Commerce

43.74

3.07

Market

48.12

1.00

Internet

126.23

2.63

Entertainment Tech

686.96

1.87

††† Source: A. Damodaran, January 2005

According to DNJournal.com, domain name VCs and investors are looking to acquire domain names at PE ratios of 5-7. Moreover, Marchex has reportedly paid about 8 times the annual earnings for the Ultimate Search, a $164 million portfolio of approximately 100,000 domain names purchased last fall.

These reported ratios are relatively low as indicated by the following observations:

  1. Domain name PE ratios are about half that of the lowest industry group (Table 1 above) and are less than 13% of that of an average stock.
  1. Marchex - MCHX (NASDAQ NM) Ė has a PE ratio of 219.7, which is 27 times the ratio it paid for the Ultimate Search portfolio.
  1. Domain name earnings tend to be underestimated. Estimated earnings for a domain name typically assume that it is parked, which is not necessarily the best use of a domain name. Using such earnings data tends to underestimate a domain nameís earning number in the denominator of its PE ratio. Thus, artificially inflating the PE. Hence, although it seems that investors are paying high ratios, the actual PE is lower than the reported 5-7 multiples.
  1. The acquisition of a portfolio of assets is typically valued at a PE ratio that is lower than the average of individual PE ratios.

Why Are Low PE Assets Good Investments?

  • For investors who subscribe to the value investing school, one measure of value is the PE ratio. Thus, when comparing across domain name classes, a domain name that fetches, say, a PE of five is viewed as cheaper than one that trades at a PE of ten.

  • For those investors who prefer to compare what they make on domain names to what they can earn on, say, bonds, they look at the earnings yield (which is the inverse of the PE ratio, i.e., the earnings divided by market price). For example, a domain name with a PE of 5 has an earnings yield of 20%, which may provide an attractive alternative to bonds yielding less than 5%.

  • PE ratios vary across classes. Thus, PE of a traffic domain name selling at 4 is considered undervalued to the range of its peer group with an average PE of 5-7.

Thus, domain names are a bargain at the current PE ratios.