Dotcom Bubble

The Dotcom Bubble was an economic bubble that affected the prices of stocks related to the technology industry during the late 1990s and early 2000s in the United States. The event was triggered by the hype over the new Internet industry, media attention, and investors' speculation of profits by dot-com companies.

From 1995 to 2000, Internet-based companies' stocks at the NASDAQ Composite Index experienced exponential growth of over 400% in their prices. However, the bubble then burst in 2002, and the stock prices fell to around 78%. Many companies did not survive the crash, and the whole US economy was heavily affected by it.

Key Takeaways                                                               

• The Dotcom Bubble was heavily influenced by the rise of the Internet and the media attention it received. At the time, it seemed like a great opportunity, not a pitfall.
• In a short timeframe, venture capital investors grew over six times, going from under $5 billion per year in the US to over $30 billion in 2000.
• Some companies, such as Amazon.com, survived and are very successful today, while others crashed and failed to sustain their services after 2000, such as Pets.com.

The Internet

The dotcom bubble was created due to the popularization of a new invention - the Internet. It existed before the 1990s, but that is when it was democratized. So, several technology start-ups with a “.com” domain started offering businesses based on that new growing industry. However, the problem was that they did so without proper business planning and cash flow generation.

Speculation

Back in 1995, the market was already starting to feel like the future. Computers went from luxury to professional necessity, and it was visible that the world was changing. Then, venture capitalists noticed that, and the speculation on the market started.

Investor Hype & Overvaluation

Among the causes for the dotcom bubble, the most obvious was the hype. Investors saw these firms as a surefire way to make a quick profit, so they hyped them up and overvalued them. However, most of them did not have the clientele yet to become as profitable as they looked like they would be.

Instead of analyzing fundamentals, most investors went on an investment spree to capitalize on the growing price of stocks. There was also a media frenzy at the time, which created a very positive sentiment.

Alan Greenspan’s Speech

A speech by Alan Greenspan on December 5, 1996, is considered one of the catalysts that set up the dotcom bubble. The then-chairman of the US Federal Reserve, Greenspan warned about the irrational exuberance of the financial market, which was supposed to take down the market but was viewed as a strong signal of confidence.

Taxpayer Relief Act of 1997

Another factor that caused the dotcom bubble was the Taxpayer Relief Act of 1997. It effectively diminished tax on capital gains, causing investors to become more prone to speculate in the financial market. Also, as it was more profitable, and investors had more money to do it.

Most of the companies did not have a profitable business or enough clients to remain so for a long time, so when the cash stopped flowing in, they faced a downturn.

Charts can help us to understand just how crazy the market was during the dotcom bubble. The one below shows how the NASDAQ Composite Index, which is made up mostly of technology companies, rose during the timeframe of the dot com bubble:

Source

In the chart, it is visible how the index did not rise above 1000 points before 1996. But it kept constantly increasing in the following years, peaking during 2000 at around 5000 points, a rise of 400%. After that, it crashed heavily, meaning that everybody who invested after 1997 was likely to lose money in the bear market that followed.

Another chart tracks all venture capital investments in the United States from 1995 to 2017:

Source

As we can see, during the peak of the dotcom bubble, investments were over $30 billion quarterly. It is over six times the amount of money that was invested during most years in the 1990s. The exaggeration was so big that in 2015 when investments were peaking again, these were hardly above $20 billion.

Not every company faced the same result after the dotcom crash, but some thrived and ended up as big businesses while others did not survive in the early 2000s. Here, we will present two very contrasting examples - Pets.com and Amazon.com.

Amazon.com was perhaps the most successful of companies that survived the dotcom crash and essentially dominated the world down the road. Initially, its stocks were sold for a dollar each, on average. However, before the end of 1997, the company was already selling them for almost $5.

The stock value soared from $4.5 to $92 at the beginning of November in 1998, indicating even higher growth. During 1999, the price of each share went up to almost $100, a jump of around 9,000% within two years.

However, soon after that, the stocks crashed. By the end of 2001, they were worth something between $6 and $7. Ever since 2010, Amazon’s stocks are growing. During 2020, they were valued at over $3,000 for the first time, and this time it seems that the growth may be more sustainable.

Not all companies survived, though, and Pets.com is an example of it. The pet supply company allowed people to buy food and litter for their pets online. However, it undercharged its shipping services, which made it unprofitable.

The company's initial public offering (IPO) was funded by Amazon.com and was deemed successful. But it was released in 2000 when the market was collapsing. Stocks started at $11 but soon spiraled down to below $1, and the company had to shut down.

Not only did the dotcom bubble cause a mild recession, but it also shook the confidence in a new industry, which had a far more lasting effect. It was so widespread that even successful companies that had a long and profitable business took a hit.

For instance, the stocks of Intel, which was in the financial market since the 1980s, crashed from $73 to around $20 to $30. The company was not directly related to the dotcom bubble, but it was affected nevertheless. At the time, prices are higher than during the 2000s, but they took a long time to grow up again.

Overall, the effect was much worse for investors than for the companies. According to the New York Times, about 48 percent of all dot-com firms survived the crash, although most of them lost a significant portion of their value. For example, the sudden spike in the issuance of IPOs by new technology companies, including GameStop and many technology stocks reaching all-time high in 2021 have concerned many investors of a potential economic bubble.

However, there is a way to prepare for a similar event. And that is knowing that every bubble follows a pretty simple rule - they are all about the hype. By researching each company individually and carefully, one may avoid getting on the hype train and losing their money. Also, rather than investing in a company's future, one should focus on how they do now.