Why I Won’t Buy Demand Media Stock

by John Soares on January 31, 2011

Demand Media (DMD) just did its initial public offering of stock on Wednesday, January 26, 2011.

For those of you that don’t know the company, it owns a series of websites (such as ehow.com) that contain many  thousands of articles primarily written by low-paid freelance writers, articles designed to rank high in Google and other search engines for currently popular search terms. The sites run advertising, a key source of Demand Media’s revenues.

Many, many other bloggers have examined the pros and cons of writing freelance articles for such content farm/content mill sites. I won’t rehash those arguments here.

My purpose is to point out why I think buying Demand Media stock is likely a bad idea, especially for long-term investors. I’m no expert on picking stocks; however, I have been buying and selling stocks, ETFs, bonds, and mutual funds since 2005.

So, from my personal investing rules, here are…

3 Reasons Why I Won’t Buy Demand Media Stock

1. Demand Media Is Losing Money

I don’t buy the stock of a company that’s losing money. Some companies that are losing money now are well positioned to make a lot of money later and could be a good investment. Many, many others continue to lose money, keep trying to find more financing, issue more stock, and eventually spiral down into a penny stock, perhaps to disappear forever. Yet others muddle along for years losing money. It’s not clear what DM’s path will be.

Update: Demand Media was profitable in the fourth quarter of 2010. There’s good analysis in this article, along with this summary:

DMD turned a profit of $1 million in the last three months of 2010, however, because of the conversion of preferred shares to common stock as part of the firm’s recent IPO, the books show a loss of $7.6 million, or 54 cents per share. The $1 million profit compares with a loss of $3.9 million in the prior year period. Revenue for the fourth quarter hit $73.6 million, marking a 33-percent year-over-year increase.

2. Demand Media Is Overvalued

Determining the value of a company that’s losing money is a bit complicated, so I’m relying on the analysis of Kevin Berk at Seeking Alpha in his recent article “The Bubble Is Back: Will Demand Media Go Below $10?” He thinks the company is way overvalued compared to similar technology companies.

3. Demand Media Is Dependent on Current Search Engine Algorithms

There’s credible evidence that Google isn’t happy with how well content farms rank in Google’s search engine. A crucial component of Demand Media’s business model is making page one of Google searches. If the big G makes changes that pushes those articles off page one, DM’s revenues will take a big hit.

The Future?

Demand Media stock would only interest me if the company can demonstrate that it can consistently make increasing amounts of money over the long term, and I’m skeptical of that.

Disclosures

I’m not giving you specific advice on when and how to buy or sell any stock or financial instrument. You need to do your own due diligence for all financial transactions, and that includes getting the advice of competent professionals. I have not engaged in any transactions involving Demand Media stock.

Your Take

What’s your view on the value of Demand Media stock? What do you see for the future of the company?

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    { 23 comments… read them below or add one }

    1 Roy Scribner January 31, 2011 at 8:06 AM

    Twitter: @throwingabrick

    No doubt, John – we are going to see a flurry of social media companies going to the public markets, over the next two years. Most of these will not have solid business plans and, once again, we will be hearing a lot of “the old rules do not apply” jargon.

    Reply

    2 John Soares January 31, 2011 at 11:10 AM

    Yes, I’m wondering if it will be like 1999 all over again, and I’ve read several articles making that point.

    A key point for me is profitability at the time of the IPO and a strong indication that profits will grow with time.
    John Soares recently posted…Why Freelance Writers Should Specialize

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    3 Anne Waymn January 31, 2011 at 12:50 PM

    Twitter: @annewayman

    Can anyone say bubble? Even back in the day when I was part of it I didn’t understand why folks bought stock in companies that lost money. Demand and cos like them are thrashing around trying to fill a need. Meanwhile really smart companies are hiring good writers, paying them well, and not trying to fool search engines.
    Anne Waymn recently posted…Freelance Writing Jobs For Monday- January 31- 2011

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    4 John Soares January 31, 2011 at 4:45 PM

    Hear, hear for companies that hire quality writers and pay them accordingly.

    Companies that rely primarily on getting on page 1 of Google will live or die based on the changing temperament of the Google god.
    John Soares recently posted…Download my Podcast on Freelance Writing for College Textbook Publishers

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    5 Dave Doolin February 1, 2011 at 5:59 AM

    Twitter: @doolin

    At some point, someone will implement a browser kill file, and we will be able to filter all search results from Demand Media, efreedom, experts-exchange, and the whole lot of these sites that exploit labor or “free” content rake off ad revenue. Or maybe we can do this now? Anyone know?

    Google has gotten pretty good at not serving up anything scraped off of Wikipedia, at least they don’t seem to display scraped content on the first pages. Took a few years though.

    Reply

    6 John Soares February 1, 2011 at 7:24 AM

    Dave, I don’t know if browsers will soon offer the ability to filter out certain content or specific sites. I know that Google offers a search filter that attempts to keep porn sites out of search results.

    A couple of points here:

    1. To my knowledge, most or all of the content on Demand Media sites is original or licensed, so it’s not scraped. (I realize you weren’t saying DM scrapes other sites.)

    2. While some (much?) of the content from Demand Media sites may be of questionable quality compared to other sites, some of it can also be quite useful. I read an eHow article awhile back about how to remove a certain type of stain from clothing: the advice worked.
    John Soares recently posted…Top 10 Ways to Generate Great Ideas

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    7 Fred Leo February 1, 2011 at 9:01 AM

    Twitter: @solobizcoach

    John,

    While I can’t really comment on your points #1 and #2, I think you are completely right about point #3. While I don’t know how Demand Media will fair after future Google algorithm changes, but I do know that Google will change its algorithm many times in the next few years. I think that predicting the value of Demand Media’s stock given these certain algorithm changes is very tough.

    I run about 15 websites, and many of them are dependent on Google delivering traffic to them. I have lived through 2 major algorithm changes, and I can’t predict the value of my own sites let alone Demand Media’s sites.
    Fred Leo recently posted…Get Rid of Writer’s Block Once and For All

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    8 John Soares February 1, 2011 at 10:14 AM

    Fred, the good possibility that changing Google algorithms will negatively affect Demand Media is a key weakness of the company’s business plan.

    I’ve also seen the search traffic to my own sites rise suddenly, and also drop suddenly.
    John Soares recently posted…Download my Podcast on Freelance Writing for College Textbook Publishers

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    9 Brown Eyed Mystic February 1, 2011 at 8:06 PM

    John,

    Great post. I think I would invest only if I saw DM changing their strategy from having under-paid, low-quality material to having decent-costing, high-quality material from writers who have a following or those who have a strong hold of their respective niches. Only when DM starts to publish quality content, can Google consider them again with their new algorithm. Otherwise, it’s unlikely that I will invest.

    -BrownEyed

    Reply

    10 John Soares February 2, 2011 at 7:43 AM

    It would be great if Demand Media would start paying much higher rates. But their business model depends in large part on creating many thousands of articles quickly and cheaply that will rank in search engines.
    John Soares recently posted…Why Freelance Writers Should Specialize

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    11 John Soares February 2, 2011 at 8:00 AM

    Those of you who follow me on Twitter may know that I’ve been tweeting about the financial troubles of Borders, one of the two major bookstore chains in the United States. (Ticker symbol BGP) Borders stock has dropped by half since yesterday on a report the company may declare bankruptcy soon.

    I’m not at all saying that DMD will eventually go the way of Borders, but if you investigate the history of Borders over the last 3 years or so, you’ll see what can happen to company that keeps losing money. Just enter BGP in Google finance or Yahoo finance to get recent articles or track the stock price.

    I bought several books at the Borders in Santa Cruz, California just a few weeks ago when I was house-sitting in the area, and I do hope the company can turn itself around.
    John Soares recently posted…What’s the Best Use of Your Time Right Now

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    12 Delena Silverfox@YouLoveCoupons February 2, 2011 at 4:13 PM

    Twitter: @AboriginalMama

    Honestly, I don’t invest in stocks, bonds, or mutual funds after reading Robert Kiyosaki’s Conspiracy of the Rich, but I still find it interesting to watch them just to learn firsthand what Robert means when he teaches about the stock market.

    However, while every great once in a while you’ll find an article on eHow that’s quality, I think DM has shot themselves in the foot with their business model.

    Yes, you can make a lot of money being cheap and easy, but eventually people catch on and you’ve just built bad reputation. People catch on. I’m glad it looks like Google’s catching on.
    Delena
    Delena Silverfox@YouLoveCoupons recently posted…iContact Coupon Code

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    13 John Soares February 2, 2011 at 4:57 PM

    Delena, thanks for writing. Not everyone, including me, is a fan of Robert Kiyosaki. Most investment advisors say we should diversify our investments across different classes of investments, and that includes stocks and bonds.

    I recommend Vanguard Wellington as a good fund with a mix of stocks and bonds, and a very low expense ratio, but there are many others out there.
    John Soares recently posted…What to Do If You Take a Blogging Break

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    14 John Soares February 8, 2011 at 12:15 PM

    Demand Media, DMD, will announce its fourth quarter and 2010 annual results at 2 p.m. Pacific time on Tuesday, February 22. More details here: http://finance.yahoo.com/news/Demand-Media-to-Announce-bw-454795276.html?x=0&.v=1

    It’s all about expectations, and its likely the stock price will move significantly up or down depending on the results and the company statements.
    John Soares recently posted…Why Publishers Should Pay a 50-Percent Royalty on E-Books

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    15 fran Civile@boomers making money February 17, 2011 at 3:20 AM

    Twitter: @francivile

    I’ve enjoyed this interesting conversation although I don’t invest in stocks. Demand Media was only familiar to me for their reputation in the freelance writing world.

    But I started out reading your article about the book sales statistics and wandered into reading several other articles! The growth of ebook sales is notable and it seems that the various iterations of Kindle like readers is going to promote even more growth in that area, don’t you think?

    Fran
    fran Civile@boomers making money recently posted…Apprentice Marketer Gazette Gets Reviewed by Blog Tyrant!

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    16 John Soares February 17, 2011 at 6:13 AM

    Fran, there’s no doubt that ebook sales will be a larger and larger share of all book sales. It’s quite possible that in a few years most people will be reading books on readers.
    John Soares recently posted…2010 Book and E-Book Sales Data for the United States

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    17 Colin February 22, 2011 at 7:09 AM

    I know that DM publish content about anything and everything, but what do you all think of publishing in niche markets using a similar model to DM. DM publish articles on their websites like ehow etc, but if the model was spreading that content across content specific websites, would it be better? A lot of content networks that publish in niche markets, but plenty of them, are highly successful.

    Reply

    18 John Soares February 22, 2011 at 9:21 AM

    Colin, many online marketers set up sites selling merchandise, or links to affiliate products like those on Amazon.com, and they try to drive traffic to those sites through posting lots of articles (often blog posts) on those sites, or by submitting articles to article directories like ezinearticles.com.

    Some do have success with it, but it depends on the quality of the niche, how crowded it is, and the efforts of the individual marketer.
    John Soares recently posted…How to Succeed at Co-Authoring

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    19 Colin February 22, 2011 at 9:31 AM

    Absolutely! It’s a tough gig.

    One other thing. How easy or hard do you think it is to start a company like DM. It’s such a simple concept, but does it take huge investment?

    I know I am getting off topic a bit, but it seems so simple yet they have just done their initial IPO so they must be huge!

    Reply

    20 John Soares February 22, 2011 at 9:39 AM

    Yes, such an undertaking is huge and requires tens of millions of dollars. They had venture capital funding prior to doing their IPO. Demand Studios hired thousands of writers to write hundreds of thousands of articles.
    John Soares recently posted…Get Permission to Use Copyrighted Photos

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    21 Devon Ellington February 23, 2011 at 1:28 PM

    Twitter: @DevonEllington

    If I won’t work for them (they can’t afford me, I make between 10 and 100 times their going rate), why would I support them by buying stock in the company? I would consider that hypocritical.

    I do careful research of the company offering the stock, and I don’t base my purchase solely on what I think is profit potential, but if I think the company is ethical.
    Devon Ellington recently posted…Wednesday- February 23- 2011

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    22 John Soares February 23, 2011 at 1:44 PM

    Devon, I base my buying decisions on individual stocks based on both my evaluation of whether the stock will go up and also — like you — on whether or not I support what the company does.

    I’ve actually sold off nearly all my individual stocks over the last couple of years and now invest primarily in mutual funds and some real estate.
    John Soares recently posted…How to Succeed at Co-Authoring

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    23 Joe @ Demand Studios September 28, 2011 at 1:42 PM

    Twitter: @dsreview

    I have to agree, Demand Media stock is not worth buying. Unless you want to buy it low, which it is right now, and sell it short. You could make some money that way perhaps. But yeah, otherwise, steer clear.
    Joe @ Demand Studios recently posted…Demand Studios Review

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