What Was The Dot-com bubble? The Dot-com Bubble And Why It Matters To Understand The Evolution Of Tech Business Models

The dot-com bubble describes a rapid rise in technology stock equity valuations during the bull market of the late 1990s. The stock market bubble was caused by rampant speculation of internet-related companies. In part, this was caused by the easily available liquidity in the markets combined with the rise of Internet companies. After the dot-com bubbles, the survived Internet companies learned how to master a leaner playbook.

Understanding the dot-com bubble

The origins of the dot-com bubble can be traced back as early as 1993 when the first web browsers gave users access to the World Wide Web. Four years later, the percentage of households owning a computer in the United States increased from 15% to 35%. This heralded the beginning of the Information Age, where computer ownership for ordinary citizens transitioned from a luxury to a necessity.

Around the same time, the United States federal government introduced the Taxpayer Relief Act of 1997 to lower marginal capital gains tax. In combination with a decline in interest rates and increased availability of capital, the measure caused individuals to make speculative investments in any dot-com company. Venture capital was readily raised and investment banks encouraged further speculation in technology companies because they benefitted enormously from their IPOs. 

Speculation caused share prices to rapidly increase as investors overlooked traditional metrics such as price-to-earnings ratio, debt/equity ratio, and amount of free cash flow. Indeed, the NASDAQ composite index rose 400% between 1995 and 2000 with an unsustainable price-to-earnings ratio of 200.

At the height of the dot-com bubble, instances of private investors quitting their day jobs to trade on the financial market were common. What’s more, it was perfectly feasible for a dot-com company to raise a substantial amount of money through an IPO – even if it had not realized a profit or, in some cases, earned any operating revenue. Many of the employees of these companies became instant paper millionaires in the process.

The bursting of the dot-com bubble

In an attempt to rein in equity prices, the government raised interest rates three times in 1999 and a further two times in 2000. Following its lead, Wall Street analysts began advising their clients to reduce their exposure in internet stocks because it was no longer undervalued. 

The NASDAQ peaked on March 10, 2000, at 5,048. This represented a near doubling of its value over the previous year.

Inevitably, capital began to become scarce as valuations reached astronomical levels. Companies such as Dell and Cisco placed large sell orders on their stocks near the peak, which caused panic selling among investors.

Companies that had held an IPO based on questionable business models or without solid financials quickly burned through their cash and declared bankruptcy.

In October 2002, the NASDAQ had slid to 1,114 – representing a decline of 80%. It would not recapture its previous highs until March 2015. 

Though exact figures are difficult to ascertain, it is estimated around 4,800 of the enterprises launched during the boom disappeared, with trillions of dollars in wealth being lost almost overnight.

Key takeaways:

  • The dot-com bubble describes a rapid rise in technology stock equity valuations during the bull market of the late 1990s. The stock market bubble was caused by rampant speculation of internet-related companies.
  • At the height of the dot-com bubble, instances of private investors quitting their day jobs to trade on the financial market were common. Thousands of companies held profitable IPOs despite earning no profit or even revenue in some cases.
  • The dot-com bubble began to burst after interest rates were raised five times between 1999 and 2000. Wall Street analysts, perhaps seeing the writing on the wall, advised investors to lower their exposure to dot-com stocks. The NASDAQ peaked in March 2000 and had lost 80% of its value by October 2002.

From the burst of the dot-com bubble a few key companies not only survived but thrived, below some examples:

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