dot-com-bubble

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:

Related Financial Bubbles

Tulip Mania

tulip-mania
Tulip mania was a period during the 17th century where contract prices for tulip bulbs reached extremely high levels before crashing in 1637. The causes of tulip mania have perhaps been distorted over the centuries, with many assuming it was one of the first examples of a market bubble bursting. However, the proliferation of once rare tulip bulbs probably lead to them becoming less desirable. Tulip mania remains a popular term to describe markets where high prices are associated with low value or low utility items, including baseball cards, Beanie Babies, and NFTs.

South Sea Bubble

south-sea-bubble
The South Sea Bubble describes the financial collapse of the South Sea Company in 1720, which was formed to supply slaves to Spanish America and reduce Britain’s national debt. Investors saw the potential for the South Sea Company to collect interest on the loan in addition to collecting profits from its gold, silver, and slave interests. Positive sentiment was also driven by the actions of the government. Lucrative trade profits never materialized, which caused the share price to become dangerously overvalued. Instead, the South Sea Company operated more like a bank and less like a shipping business. Capital invested from waves of new investors was redistributed to older investors in an early Ponzi scheme. The share price crashed in December 1720, with many South Sea Company directors impeached or imprisoned.

Mississippi Bubble

mississippi-bubble
The Mississippi bubble occurred when a fraudulent fiat banking system was unleashed in a French economy on the verge of bankruptcy. Scottish banker John Law proposed that the French transition from gold and silver-based currency to paper currency. Law theorized that he could sell shares in the Mississippi Company to pay off French national debt. When the company secured total control of European trade and tax collection, investor speculation increased to unsustainable levels. The company share price reached its peak in January 1720 as more and more speculative investors entered the fray. Law continued to issue banknotes to fund share purchases, which inevitably caused hyperinflation. Less than twelve months later, shares in the Mississippi Company declined by 1900% and Law had to flee France in disgrace.

Stock Market Crash of 1929

stock-market-crash-of-1929
The Stock Market Crash of 1929 was a major American stock market crash in October 1929 that precipitated the beginning of the Great Depression. Black Friday, Black Monday, and Black Tuesday are terms used to describe the calamitous fall of the Dow Jones Industrial Average over three days. The index would slide further in the following years and would not recapture its pre-crash value until November 1954. The Stock Market Crash of 1929 was caused by complacency during the economic prosperity of the 1920s with many new investors buying stocks on margin. Government mismanagement and company share prices that did not reflect their true value were also contributing factors.

Japanese Lost Decade

japan-lost-decade
The Japanese asset price bubble resulted in greatly inflated real estate and stock market prices between 1986 and 1991. During the late 1980s, the Japanese economy was booming as a result of exuberance in equity markets and skyrocketing real estate prices. The Nikkei stock market index reached a peak of 38,916 on December 29, 1989. The bubble burst soon after as the Bank of Japan raised bank lending rates to try to keep inflation and speculation in check. The economy lost over $2 trillion in value over the next twelve months. The Japanese asset price bubble was primarily caused by bank deregulation and expansionary monetary policy. Japanese banks who had lost their corporate clients instead lent to riskier small and medium enterprises. The 1985 Plaza Accord trade agreement also caused a sharp appreciation in the yen, which caused massive speculation that the Bank of Japan was happy to ride for years.

Dot-com Bubble

dot-com-bubble
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.

Global Financial Crisis

global-financial-crisis
The global financial crisis (GFC) refers to a period of extreme stress in global financial markets and banking systems between 2007 and 2009. The global financial crisis was precipitated by changes to legislation in the 1970s. The changes created the subprime mortgage industry and forced banks to loosen their lending criteria for lower-income borrowers. When the subprime market collapsed in 2008, one-fifth of homes in the United States had been purchased with subprime loans. Bear Stearns and Lehman Brothers collapsed because of their excessive exposure to toxic debt, while consumers were left with mortgages far exceeding the value of their homes. In the aftermath of the GFC, interest rates were reduced to near zero and there was sweeping financial reform.

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