Studies & Opinions
Review of What You can learn from the Stock Market”[1]
Alex Tajirian
September 21, 2007
Abstract
Below we demonstrate that the reviewed
article’s analogies between domain names and stocks are flawed,
and thus that the resulting parallels are not illuminating.
Is the analysis valid?
As the title suggests, the objective
of the article reviewed below is to draw similarities between
stocks and domain names,[2] and then to use these similarities to suggest
domain-name investment strategies. However, for such an approach
to be fruitful, the analogy must be based on a valid one-to-one
correspondence between the analogous elements. If the identified
similarities are also applicable to other classes of assets, the
implications become ambiguous.
We examine the arguments in the order
they are made.
For a start, the title is misleading
because the article compares assets, not markets. Comparing markets
would involve issues such as exchange mechanisms, efficiency,
transactions costs, and liquidity.
The first paragraph notes, “With a multitude
of investment opportunities to choose from, speculating on domain
names is a fairly recent occurrence.”
Although the
statement is true, it is not clear whether speculation is being
equated to investment, which are two distinct approaches to make
money. Making money on domain names lends itself to fundamental
analysis, and thus, financial valuation and investment techniques
can and should be employed.
“Stocks provide dividends and the potential
for capital growth. Similarly, domains provide revenue and growth
potential. Domainers can earn revenue from domains through parking
(similar to a stock′s dividends) and sell them for profit
(similar to the way capital growth is expressed in the stock market).”
Investment in
bonds and interest-bearing money market accounts, for example,
also yields periodic income. Thus, earnings from parking are also
similar to earnings of other classes of financial instruments.
Moreover, an analogy can also be made between the cash flow components
of domain names and bonds, given that bond investors earn periodic
interest and can sell the bond at any time for a profit or loss.[3] As investment strategies
in different financial assets vary, the article’s cash flow analogy
is not unique to stocks. Hence, adopting stock-specific investment
strategies to domains becomes fatal. Furthermore, dividends and
parking income are different in the following respects:
(a) Typically,
divided payments are constant[4] unless they are announced
as special distributions. On the other hand, parking revenue
depends on the domain name’s earnings for the period, and thus,
has a large random component.
(b) There are typically severe market price penalties for
missing a regular dividend. On the other hand, parking revenue
fluctuations are expected and do not necessarily have a disciplining
effect on the monetizer in terms of the threat of the investor
allocating domains to a competitor when revenue drops.
(c) A large number of Fortune 500 companies, especially high
tech, do not pay any dividends.[5] Thus, the periodic cash
flow/revenue analogy fails. Nevertheless, there are situations,
other than trademark-related, whereby the owner may be better
off with a non-active site and forgo parking revenue.
“The main factors determining the value
of a domain name are:
· (Future) resale value: Domains with the greatest resale
value are those that are catchy, short, and have good advertising
and branding potential. They should also have a common top-level
domain (TLD) such as .COM. If a domain has all those characteristics,
there′s a high likelihood that someone will buy a name at
a premium in the future. However, the emphasis is really that
this is future growth potential!”
Aside from the issue of the feasibility
of quantifying the phrases “catchy” and “have good advertising
and branding potential,” domain name length is practically irrelevant
and is not as significant as many practitioners suggest.[6] Moreover, what does the
article mean by “someone will buy a name at a premium in the future”?
Premium over what? Is
it over registration cost? If I buy a domain name with the suggested
characteristics, will there be a high likelihood that I would
be able to sell it at a premium? Nevertheless, even if a domain
name has no growth potential but is expected to generate a solid
constant parking revenue, it will also have a high value. Thus,
growth per se is irrelevant in determining future prices; it is
unexpected growth that drives additional value.[7]
· (Current) Traffic: The quantity and quality of traffic influences
the value of a domain.”
Current traffic is not a factor in
determining price. The real factor is expected future cash
flows, of which the resale value is only one component. Yet
the article ignores the intermediate parking revenue stream.
Nevertheless, current traffic may or may not be a good predictor
of future parking revenue, not only because of idiosyncratic
risk factors but also because revenue depends on who is doing
the monetization and for how long, and on whether the domain
name is appropriate for parking versus, say, leasing.[8]
“If you look at the stock market,
two major forces also drive the valuation of a stock:
· (Future) growth: A company which will be able to grow fast
(and make profits in the future) is valued higher than a low-growth
company.”
A company that is able to grow fast
and generate future profit is not necessarily valued higher than
a low-growth company. In
fact the growth rate can be zero and still have a higher value
than a very high-profit-growth company. Compare, for example,
the market value of a utility company with that of a high-growth
start-up.
· “(Current) profits/EPS: A company which is more profitable
is valued higher than a low-profit company.”
-
It is a well-known fact that EPS can be artificially inflated. Thus, it is not
necessarily a good measure of value or performance.
-
The article points out that for typo domains “the growth is limited.”
But, if the cost-per-click (CPC) and search volume for the
non-typo domain key word have high growth potential, everything
else being equal, wouldn’t the associated typo domain name
have growth potential too?
“Takeover Targets (e.g.
Chrysler) - Stocks that have both low growth and profits. In the
domain world, these are called Junk Domains (e.g. myjunkdomain.net).
Junk domains earn lower parking revenue and do not have much value
in an aftermarket.”
It is not obvious why companies with
“both low growth and profits” are takeover targets, as defined
by the article. Using their domain name analogy, would have they
classified, for example, Joost.com as junk few years ago? Moreover, with junk domain names as “Takeover Targets,”
why not invest in junk domains and reap the benefits of acquisition
premiums?
The article goes on to classify games.com
as a “star” domain (with both high growth rates and earnings)
and vodka.com as a “growth” domain (rapid price growth with little
profit). It is not clear how they arrive at the classifications,
especially when there are no market prices for vodka.com.
“Purchasing growth stocks can certainly pose
a risk with their high growth potential and low immediate profits,
however many are rewarding in the long run.”
US Treasury
bonds face risk too, namely inflation risk, without having any
cash flow growth potential. However, relatively efficient markets
in the US reward investors for assuming risk.[9] What indication do we have that domain name markets will, on average,
reward risk bearing? In fact, statistical studies show that domain
name markets are inefficient, and thus, provide unfair reward.[10]
“As familiarity with the market increases,
domain investors are not just investing in .COM domains, but have
experienced success with branching out and adding an array of generic
top level domains (gTLDs) such as .INFO, .NET, and .BIZ. Also included
in the selection may be country code top-level domains (ccTLDs)
including .US, .CO.UK, .DE and .TV. Even sponsored top level domains
(sTLds) such as .MOBI are included to diversify and internationalize
domain portfolios.”
It
is true that investors are buying other than .com domains and
that such an acquisition strategy is rational. However, the idea
that such purchases “are included to diversify and internationalize
domain portfolios” is not necessarily correct. If the domain names
in a portfolio, irrespective of their extensions, generate parking
revenue from, say, only ads of US companies, diversification across
extensions is equivalent to increasing the size of the portfolio
and does not provide unique benefits. For parked domains, diversification
across extensions is valuable when advertising is related to ad
performance of other countries and when there is foreign exchange
risk associated with the currency of revenue payments.[11]
The final recommendation in the article
is to “Buy low, sell high!”
First, this recommendation is not fully compatible
with a diversification approach to domain investing, as diversification
works irrespective of the investor’s ability to identify lows
and highs.[12] Moreover, there is strong empirical evidence that stock picking
in US markets yields, on average, a lower return than a buy and
hold strategy.
Concluding Remarks
We provided evidence that the reviewed article
demonstrates a lack of understanding of basic stock valuation models
and a lack of understanding of diversification drivers. Thus, any
of the article’s implied domain-name investment recommendations
are dubious.
One can only hope that
Sedo’s domain name appraisal methodology is not based on financial
valuation, and that the authors are not involved in performing such
appraisals.
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