Dot-Com Bubble

Time occurred

1995 – 2000

Overview

During the late 1990s and early 2000s, the widespread adoption of the World Wide Web and the Internet led to the creation of many new technology companies and a skyrocketed stock price due to investors’ optimism about their potential to revolutionize commerce, media, and communication.

As a result, the dot-com boom of 1995–2000 was a period of large, rapid, and ultimately unsustainable increases in the valuation of shares in Internet service and technology companies (commonly referred to as “dot-com” companies) with little or no record of profitability or unrealistic business models. By 1999, 39% of all venture capital investments were going to Internet companies.

After years of rapid growth and speculative investment in internet-based companies, the dot-com bubbles finally burst in 2001-2002. During this period, the U.S. Federal Reserve increased the interest rate to counter the inflationary pressure and borrowing became more expensive which triggered a chain of reaction, as investors started pulling out of high-risk ventures, leading to a steep market correction.

Adopted image from Link

What caused the Dot-com bubble?

The Hype and Speculative Investment Behaviour

The rapid development and commercialization of the Internet led to high expectations for E-commerce businesses for growth and profitability. Media outlets and stock analysts also played a significant role in exacerbating the bubble of stock investment during this time, covering the potential and success stories of internet companies, issuance of optimistic projections, and buying recommendations for dot-com stocks. As more and more investors poured money to invest in dot-com companies, it further inflated stock prices.

As traditional valuation methods could not be applied to value these new types of Internet companies and investors prioritized valuation metrics such as price-to-sales, many tech companies turned to aggressive accounting practices to exaggerate their revenue or simply poured significant resources into marketing to build brands that would set them apart from competitors.

The lack of understanding by investors and the failure of many internet companies to establish viable, profit-generating business models ultimately resulted in the bursting bubble after these companies went public through initial public offerings (IPOs) at incredibly high valuations based on future potential rather than current performance.

Economic Environment

While venture capitalists, investment banks, and brokerage firms were criticized for inflating the value of dot-com stocks to profit from the surge of IPOs, the true force behind the Internet bubble was the Federal Reserve’s monetary policy.

In the late 1990s, the Greenspan Federal Reserve’s aggressively low interest rate policy made borrowing cheap, encouraging investment in riskier ventures like dot-com startups that sparked the surge in the tech industry. The Taxpayer Relief Act of 1997, which lowered the top marginal capital gains tax in the United States, also made people more willing to make more speculative investments.

Meanwhile, the U.S. economy was experiencing a period of strong growth, which contributed to investor confidence and the willingness to take on more risk.

Consequences

Economic Impacts

The burst of the Dot-Com Bubble led to a sharp decline in stock prices, particularly in the technology sector. The Nasdaq Composite Index, which had soared during the bubble, plummeted by nearly 78% between 2000 and 2002. By late 2001, the majority of dot-com stocks had collapsed with an estimated 48% of dot-com companies in Silicon Valley alone shut down and lost 200,000 jobs by 2004. Even the blue-chip technology companies saw their share prices drop by over 80%.

The collapse contributed to an economic downturn in the early 2000s, known as the early 2000s recession. The downturn was exacerbated by other factors such as the 9/11 terrorist attacks and corporate scandals like Enron and WorldCom. As many dot-com companies went bankrupt or significantly downsized, it led to massive job losses in the tech industry.

A shift in financial market and investors’ mindsets

The bubble’s collapse led to increased scrutiny and regulatory changes. The Sarbanes-Oxley Act of 2002 was enacted to enhance corporate governance and financial transparency, aiming to protect investors and restore confidence in the financial markets.

Learned from lessons, investors became more cautious and discerning, with a greater emphasis on fundamental analysis and due diligence. There was a move away from speculative investments towards more value-based investing. Venture capitalists became more selective in their funding decisions, focusing on companies with solid business models and clear paths to profitability.

Dot-com companies examples

Numerous companies that symbolize the dot-com bubble – such as Pets.com, eToys, Kozmo.com, UrbanFetch and Priceline.com shared similar characteristics including an ambition to “change the world”, a rapid expansion strategy aimed at dominating markets, selling products at a loss to gain market share, extravagant spending on branding and advertising, and sky-high stock valuations disconnected from profitability or sound financial reasoning.

Adopted image from Link

Priceline.com, a standout during the dot-com bubble, initially gained widespread attention for its unique “name-your-own-price” model, allowing customers to bid on travel services such as flights and hotels. In March 1999, Priceline went public with a market capitalization of $9.8 billion, the largest first-day valuation of an internet company to that date.

However, like many dot-com companies of the era, Priceline’s business model proved unsustainable during the bubble. The company aggressively expanded into other sectors, including groceries, gas, and even cars, applying the same bidding concept. At the same time, Priceline spent heavily on marketing and branding to scale quickly, a common strategy among dot-com firms hoping to achieve market dominance.

As the bubble burst hit, Priceline’s stock price plummeted, falling from a high of $165 per share to under $2 by late 2000. Ultimately, the company retrenched, focusing on its core travel business, which eventually led to a long-term recovery, though it took years to regain stability.

References

Brian, D 2024, Dot-Com Bubble, Britannica Money, available at <https://www.britannica.com/money/dot-com-bubble>.

Brian, M 2018, A revealing look at the dot-com bubble of 2000 — and how it shapes our lives today, IDEAS.TED.COM, available at <https://ideas.ted.com/an-eye-opening-look-at-the-dot-com-bubble-of-2000-and-how-it-shapes-our-lives-today/>.

Clay, H 2023, Internet Bubble: What It Means and How It Works, Investopedia, available at <https://www.investopedia.com/terms/i/internet-bubble.asp>.

Dan, M 2022, What Was the Dotcom Bubble?, The Balance, available at <https://www.thebalancemoney.com/what-was-the-dotcom-bubble-5209336>.

Goldman Sachs n.d., The Late 1990s Dot-Com Bubble Implodes in 2000, Goldman Sachs, available at <https://www.goldmansachs.com/our-firm/history/moments/2000-dot-com-bubble>.