Internet companies have been the darling names on wall-street for more than two decades. Traders and investors alike have bet money on these stocks, with contrasting results. Some strike it rich, while others lose their fortune. So how do we pick the right names to invest in from this highly lucrative sector? Here is what experience suggests.

Internet companies rarely fit traditional valuation models, such as the dividend discount model, discounted cash flow model or multiples based valuation. This is due to various factors, a major one being lack of profits and in some cases even a lack of revenue. For example, Twitter does not have any profits to speak of, but is currently valued at $26 billion. The same can be said for WhatsApp, which has no significant revenue, but was valued at $19 billion in its recent acquisition. Most of these valuations depend on expected growth and are highly speculative in nature. However, this anticipated growth can be explosive and may not fit into estimates from traditional models, which rely on historical performance to a large extent.

Internet Valuations are Largely Driven by Non-Financial Metrics

Whether right or wrong, internet companies’ valuations are often driven by metrics like unique users and pageviews, which are difficult to express in monetary terms. Hence, ascertaining the true value of these companies becomes that much tougher. For example, the WhatsApp valuation was centered on its huge user base.

If internet companies were only valued on rules of traditional investment strategies, like value investing, this might lead to missing out on some really good investment opportunities. We need to use a mix of financial and non-financial criteria to find winners from the internet sector.

How to Value Internet Companies

Metrics like the number of unique visitors and number of pageviews are essential to track the growth of an online company. However, these by themselves are insufficient to financially value internet companies. To determine value, an investor must first look into the operating model of the company. Then, examine the monetization and engagement levels of a platform which can be estimated using specific metrics.

Operating Models Used by Internet Companies

Online operating models are typically one of two types; subscription revenue based and advertising revenue based. LinkedIn Premium service is a good example of subscription service. Advertising based operating models will typically have a service or software product offered for free usage online, and the company then generates revenue from advertising to their users. For example, Facebook and Twitter largely derive their revenue from advertising embedded in their free services.

Monetization and Engagement Metrics

Monetization strategy for effectively monetizing an online platform is extremely important to value an internet company. The effectiveness of a monetization strategy is measured by metrics like revenue per user. For companies with an advertising based revenue model, important monetization metrics also include cost per click, cost per mille (thousand) and the engagement rate, which is measured by metrics like click through rate and time spent on page. Now take a deeper look into each of these metrics.

Revenue per user: This is the total revenue derived from a platform, divided by the total number of unique users on the specific platform. It can be further classified as subscription revenue per user and advertising revenue per user.

Cost per click (CPC): This is the average cost per click charged to an advertiser for a user clicking on a sponsored advertisement.

Cost per mille (CPM): This is the average cost per thousand impressions served (displayed) on an online platform, paid by the advertiser to the owner of a website, regardless of whether the user clicks on the advertisement or not.

Click through rate (CTR): This is the percentage of advertisements displayed on an online platform which were clicked on by users. It is derived from the following formula: Advertisements clicked on a platform/Total number of advertisement impressions served on the platform.

Average time spent: This is the average time spent by every user on an online platform. This is derived from a ratio of total time spent on an online platform over a certain period and the average number of users during the same period.

These numbers, as relevant, are reported by most internet companies on a periodical basis along with their financials. Hence, an investor must look at these metrics to gauge their impact on the financial performance of a company in order to make well informed investment decisions.

We can understand these metrics and their relevance to valuations using examples from Google, Facebook and Twitter. Why are we choosing these three companies? Well, Google is by far the most successful online company with its cash machine in the form of its search engine. Facebook is another huge online platform with its billion plus audience and strong monetization improvements over the last few quarters, making it a success compared to most online platforms. Twitter, on the other hand, is relatively small and young compared to the first two, and with the recent slowdown in its user growth, its monetization strategy is under sharp focus. However, all three of these online companies derive a bulk of their revenues from online advertising, making them comparable.

The revenue of these online companies is a direct function of the number of visitors coming to their site, and the money they make per user by advertising to them. Let’s first take a look at the user base numbers for each of these companies.

Facebook (1.32 billion) and Google search (1.17 billion monthly searchers), with over a billion visitors every month are far ahead of Twitter’s current base of 271 million monthly active users. Hence, Twitter has a long way to go before it can achieve a similar scale as Facebook or Google. We look at searchers of Google as this is the total addressable advertising market for Google. Let’s now take a look at the monetization levels on each of these platforms.

We see that Facebook and Google are far bigger than Twitter in terms of scale. Also on the monetization front, Google is in a league of its own with average ad revenue per user of $46.95 (over the last twelve months) as compared to $6.90 for Facebook and $3.23 for Twitter. As an investor evaluating the three companies, we arrive at the following conclusions:

  • Twitter has room for the highest growth, followed by Facebook and Google, whether on the user base front or monetization per user metrics.
  • Google understands its users better than its competitors, which leads to better targeting of ads, reflected in its runaway Ad revenue per user. Remember, we literally tell Google what we are looking for when we search; that helps Google to target relevant ads to us.
  • Facebook has matured in terms of user base growth and has a huge growth lever in increasing its monetization levels.

We can now use the above information to value the three companies. Take a look at the current valuation multiples of the three companies displayed in the table below:




LTM PE ratio




LTM PS ratio




Source: Amigobulls

Looking at the current valuations of the three companies, we can conclude that Twitter valuations are entirely based on future earnings growth, in the absence of any history of profitability and earnings. Facebook also enjoys a valuation based on future potential with a track record of growing monetization levels and profit margins for the last few quarters. Google, on the other hand, has a history of solid profit margins and steady cash flows, though with slower current growth as compared to the other two. Valuations of Google are tied to its current financial performance with little premium for potential value.

We can classify these three stocks in the order of decreasing risk as follows:

  • Twitter: Most risky as valuations are supported by potential that is unproven in its short history.
  • Facebook: More risky than Google and less risky than Twitter, as potential valuation is supported by a strong but short history of earnings growth and solid revenue growth.
  • Google: Least risky of the three, with valuations driven by current performance rather than future potential.

The Bottom Line

Investors examining internet technology stocks should assess their risk profile and decide which stock(s) they would want to add to their portfolio. Though the sector is definitely one of the most rewarding ones, picking the wrong names will drain your wealth before you realize what happened.

More from Amigobulls:

Related Articles
  1. Personal Finance

    How Tech Can Help with 3 Behavioral Finance Biases

    Even if you’re a finance or statistics expert, you’re not immune to common decision-making mistakes that can negatively impact your finances.
  2. Investing

    How to Spot Secular Bull Markets vs. Secular Bear Markets

    A guide to identifying secular bull and bear markets.
  3. Investing

    What's Better Facebook Moments or Google Photos ?

    Facebook and Google have both released new cloud-based photo sharing services. How good are they?
  4. Brokers

    The Next Industries Bound to be Uberized

    As more startups succeed with the sharing economy business model, investors seek out businesses poised to disrupt their industries like Uber.
  5. Investing

    Will Facebook's New App Leave Siri in the Dust?

    Currently Facebook is testing its new super intelligent virtual assistant, known as, "M". Can this new AI on the block dethrone Apple's Siri?
  6. Investing

    Smart Farming Technology Storms Silicon Valley

    Silicon Valley may be known for growing tech startups, but now the iconic region is welcoming an entirely new breed of residents, startups focusing on smart farming.
  7. Investing News

    Apple and the Battle for Streaming Music

    Spotify, Apple, Youtube and Tidal are facing off for control of a vast market. What factors will determine who emerges as the leader in streaming music?
  8. Investing

    The Semiconductor Sector is On the Verge of a Breakout

    The semiconductor sector may be on the verge of a major breakout that provides market leadership in 2016.
  9. Investing

    10 Tips for Creating a Strong Digital Brand When Job Hunting

    A polished resume and cover letter are no longer enough. Companies want candidates with a strong digital brand.
  10. Chart Advisor

    These Technology Stocks are Rolling Over

    These technology looked to have topped out, and could be heading lower.
  1. Is Apple Pay safe and free?

    Apple Pay is a mobile payment system created by Apple to reducing the number of times shoppers and buyers have to pay for ... Read Full Answer >>
  2. What is the QQQ ETF?

    The PowerShares QQQ, previously known as the QQQQ, is a widely held and traded exchange-traded fund (ETF) that gives investors ... Read Full Answer >>
  3. Why does Warren Buffett largely avoid investing in the technology sector?

    Warren Buffett has often said that he avoids investing in the technology sector because he does not like to own stocks in ... Read Full Answer >>
  4. Why doesn't Warren Buffett own Apple (AAPL) stock?

    Warren Buffet claims he simply does not know how to properly evaluate Apple (AAPL) and does not feel confident in his reading ... Read Full Answer >>
  5. What economic factors influence corporate bond yields?

    The most telling signs that a tech stock is about to burst are no different from the signs of impending collapse of stocks ... Read Full Answer >>
  6. Which sectors have similar pros and cons to the drugs sector?

    In financial terms, the drug sector has a high level of risk and growth. It must gather a lot of up-front investment to drive ... Read Full Answer >>

You May Also Like

Trading Center