Economics●●●●●Difficulty 4 of 5

Was the dot-com bubble a real technology revolution or a mad crowd?

Pets.com closed nine months after its IPO, yet much of the money lost in the same mania built the Internet's backbone.

▶ Start the story

Both: the technology was real, but the prices ran far ahead of what the companies earned. The dot-com bubble was a stock market bubble that built through the late 1990s and peaked on 10 March 2000, as the Web spread and investors rushed into Internet start-ups. The Nasdaq Composite index rose 600% between 1995 and its March 2000 peak and then fell 78% from its peak by October 2002, giving up all its gains.

-78%

Fall of the Nasdaq Composite from its March 2000 peak to October 2002

What did investors believe? Rapidly rising prices and confidence that the companies would turn a profit one day led many to overlook traditional measures such as the price-earnings ratio. The Nasdaq's price-earnings ratio reached 200, against a peak of 80 for Japan's Nikkei in its 1991 bubble. A Wall Street Journal article even suggested investors "re-think" the "quaint idea" of profits. At the height of the boom, a promising dot-com could go public and raise a lot of money even if it had never made a profit, and sometimes had no revenue or finished product. Most spent heavily on advertising under mottos like "get big fast".

Then it turned. In March 2000, MicroStrategy announced a revenue restatement and its stock, which had risen from $7 to as much as $333 in a year, lost 62% in a day. Pets.com, a much-hyped company, went out of business nine months after its IPO. By then most Internet stocks had fallen 75% from their highs, and by the end of the 2002 downturn stocks had lost $5 trillion in market capitalization.

The picture is mixed rather than simply mad. Many companies endured the crash: 48% of dot-com companies survived through 2004, at lower valuations. And venture capitalist Fred Wilson, who lost 90% of his net worth in the bust, said that much of the capital invested was lost, but much of it also went into a high-throughput backbone for the Internet, plus software, databases and server structure.

Quiz me

0/3

  1. 1.What does the Nasdaq's price-earnings ratio of 200 in the bubble show?
  2. 2.Why does the story say the bubble was about prices and not about the Internet?
  3. 3.What did John Templeton's timing of his shorts rely on?

Recap

A technology can be real and its price still be a bubble: the Internet survived, many valuations did not.

💡 A trick to remember it · The cable was real, the price was air: one stayed in the ground, the other fell out of the sky.

Surprising fact · A Wall Street Journal article suggested investors "re-think" the "quaint idea" of profits.

Sources (1)

No source, no claim. Every fact in this lesson (21 claims) cites at least one of these.

  1. [1]Dot-com bubble · Wikipedia
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