dot com b

Understanding the Dot Com Bubble

In the face of what looks to be yet another tech bubble inflating in our internet age, many hearken back to over a decade ago, when a similar tech-based bubble burst: that’s right, I’m talking about the infamous Dot Com Bubble.

Many of us were there, but plenty of us were either too young or disinterested to really understand what happened. Here’s a brief overview of how the bubble started and what happened when it burst, so that you can better prepare for Silicon Valley’s next downturn.

dcb2It’s important to note the cultural atmosphere in which the Internet Bubble of the 1990’s came into existence. The late 20th century was a time when the early emergence of the Internet had created much excitement and euphoria among business professionals who looked forward to entirely new, immeasurably large frontiers to be conquered and commercialized in virtual space. To some extent, these money-makers didn’t know the half of it. On the other hand, the excitement surrounding the internet’s development was not coupled with a real understanding or ability to predict just exactly how the internet would develop. Indeed, investors believed that any company that operated online was bound to be worth millions, and that was where the trouble started.

Of course, not every dot-com was enormously successful; most weren’t, and those that did enjoy success were often tremendously overvalued. As a result, these companies crashed, and burned all their investors’ money along with it. The collapse of these internet stocks were actually more responsible for the 2001 stock market crash than the September 11, 2001 terrorist attacks. Couple together, the two events cost investors a whopping $5 trillion in total.

So how did investors manage to make such enormous mistakes with their money? Analysts chalk it up to the widespread and foolish decision among investors of the time to ignore the fundamental statistics inherent to measuring the real success of a business. Things like P/E (price to earning) ratios, market trends, and business plans went largely ignored when investors and entrepreneurs were faced with exciting and completely novel ideas that couldn’t be proven to have any market potential, but seemed to have the same “holy grail” type chances as Amazon, eBay, and other enormous and unprecedented successes. These investors then moved on to ignore blatant signs of the bubble’s imminent burst.

dcb3And how and why did that bubble eventually burst? This can be chalked up to two major reasons. The first is that analysts were too busy focusing on aspects of individual businesses that had nothing to do with how they actually generated revenue or general cash flow. At the time, investors and entrepreneurs were obsessed with a concept called “network theory” that purported that the value of a network increased exponentially as the series of computers hosting the network increased. However, in accepting this theory so blindly they forgot the fundamental issue at stake, which was whether the company could actually use the network to produce profits.

The second issue was that stocks were significantly overvalued, as analysts felt justified using extremely high multipliers in expectation of the unprecedented success that some other internet companies had enjoyed. Some companies were allegedly overvalued by as much as 40 percent.

As to whether a second bubble is forming among tech giants, it might be worth Googling… while you still can.

 

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