Passive Income Stream Valuation Methodology-Part III: What’s Your Business Worth?

July 26th, 2008 · No Comments

Price/Earnings Ratio

If you go to any finance site and look up a stock, among the many ratios and figures it will show you will be the “price/earnings” ratio or “P/E.” This is generally considered one of the most important ratios in evaluating the price of a stock. As you might expect, it is a ratio of the price of the company over the earnings of the company. (Note: Because we’re talking about a ratio, “per share” P/E and “per company” P/E are the same number.)

The terrifying world of web-price-multiples.

The terrifying world of web-price-multiples.

Example: If a company makes $2.00 per share in revenue and has a stock price of $15.00 per share, it will have a P/E ratio of 7.5. That means the company costs 7.5 times what it makes in a year.

Typically, publicly traded stocks are somewhere in the 10 to 20 P/E range, although there are plenty of exceptions.

Price Multiples for Privately Held Companies

When you move into the world of privately held companies, the multiples tend to diminish drastically. For example, if a fast food restaurant makes $100,000 per year, it may sell for a 3 to 10 P/E (versus the publicly traded company selling at a 10 to 20 P/E). This is a reflection of several things, including:

  1. Privately held companies are not held to the same stringent bookkeeping requirements.
  2. Privately held companies usually have shorter histories on which to base their valuations.
  3. Small enterprises are often much more dependent on their founders. While they may be making good money now, once the founder and his contacts and skills are gone, profits may drop drastically.
  4. Small companies are generally not worth as much as larger ones simply because “big money” doesn’t have any interest in them. Many people make money simply by aggregating small businesses and selling the aggregated company to private equity firms.
Price Multiples for Internet Businesses

As you might expect, in the internet world this multiple goes down yet again. In fact, if you go to, you will find that most small internet sites are selling for 10 to 12 times their MONTHLY earnings. That is they are trading at a P/E somewhere between 0.83 and 1 typically. So if I have a site that allegedly makes $5000 a year, I would expect to sell it for about that amount.

These low multiples represent all the same problems of privately held companies taken to the extreme. Fraud is rampant and the books are questionable to say the least. Moreover, many of these businesses are simply extensions of the founder and are basically worthless without them. Given the difficulties in assuming control of a web site, it’s no wonder people are not willing to pay as much as they will for a “real” business.

So if I can sell my site that makes $5000 per year for $5000, does that mean that it’s WORTH $5000 to me? Not necessarily.

Categories: Main blog narrative · Theory

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