When it comes to financial bubbles, the late 1990s and early 2000s dot-com bubble is one for the books. Unlike other bubbles we’ve seen, like real estate or energy, this one was unique because the internet was still a relatively new technology. Investors recognized the potential of this new way of communicating and accessing information, but nobody was quite sure how to assign a value to internet-based businesses. As a result, there were massive losses as many dot-com companies went under.
What Was the Dot-Com Bubble?
The Dot-Com Bubble, also known as the tech boom or internet bubble, was a time of excessive speculation where internet-related companies were valued much higher than their actual worth. From 1995 to 2001, internet-related tech companies attracted massive attention and investments from venture capitalists and traditional investors. This surge in funding, combined with the internet’s growing popularity, led to rapid increases in the value of web-based companies, even if many of them didn’t have clear paths to profitability. Low-interest rates in the late 1990s made it easier for these tech companies to acquire debt financing, further fueling the industry’s rapid expansion.
However, in late 2000, the easy money started to dry up, causing the industry to collapse. Many tech companies went out of business, and this downturn triggered a broader bear market that affected the entire stock market, not just the tech sector.
When the bubble burst, it resulted in a significant economic downturn in 2001. Despite the crash, some companies managed to survive and thrive afterward.
This dot-com bubble is one of several bubbles in U.S. history. Bubbles typically occur when an investment’s price greatly exceeds its actual value, as was the case with internet-based businesses during this period. Another well-known example is the housing bubble of the mid-2000s.
How Did the Dot-Com Bubble Begin?
In the early 1990s, the introduction of web browsers made the internet more accessible to everyday people. Computers, once a rarity, started showing up in more and more households, becoming something many considered a must-have. With the rise of computers and the internet, numerous new web companies emerged, all wanting a piece of the rapidly growing information technology and online commerce sectors.
By the late 1990s, low-interest rates made risky investments in stocks more appealing than safer bonds. Simultaneously, innovative Internet companies gained popularity among various investors, including retail investors, professional traders, and venture capitalists. The Taxpayer Relief Act of 1997 lowered the top capital gains tax rate, giving speculators even more reason to invest in the burgeoning internet industry.
Investment banks profited significantly by facilitating IPOs (Initial Public Offerings) for tech companies, and optimistic investors disregarded traditional indicators like P/E ratios. They poured money into young dot-com companies, many of which hadn’t yet turned a profit, fearing they would miss out on the digital gold rush that was captivating Wall Street. This influx of money acted like a bellows, inflating the unproven internet technology industry into an overvalued bubble, teetering on the edge of bursting.
Why Did the Bubble Burst?
Identifying a single trigger for the bursting of an asset bubble is often tricky, but in the case of the internet bubble, two key factors seem to have played a role in its rapid decline, which started after the tech-heavy Nasdaq composite index reached its peak on March 10, 2000.
The first factor was the rise in interest rates. The Federal Reserve increased the fed funds rate, which influences most other interest rates, multiple times during 1999 and 2000. Higher interest rates tend to encourage investors to shift their money away from riskier assets, like stocks of internet companies, and into safer, interest-bearing assets, such as bonds.
The second factor was the onset of a recession in Japan in March 2000. News of this recession quickly spread, causing widespread fear that triggered a global sell-off. More investors moved their funds out of speculative stocks and into secure fixed-income instruments like bonds.
These two factors, along with others, helped kickstart the deflation of the overly inflated internet bubble. Internet-related stocks began losing their value, sparking fear among investors and leading to more selling. This self-reinforcing process is known as capitulation, and the sell-off persisted until the Nasdaq hit its low point around October 2002.
While the dot-com bubble had devastating effects on the stock market, causing investment losses and job cuts, it did bring one specific advantage. The massive influx of capital into the tech industry led to the widespread installation of fiber optic cables across the country. This expansion greatly improved nationwide communication infrastructure, setting the stage for the growth of many modern tech companies.
One of the key factors contributing to the dot-com bubble was the lack of thorough research by investors. Investments in high-tech companies were often based on speculation rather than sound financial metrics, like price-to-earnings ratios. Some even used unfamiliar, non-quantitative quality metrics. Many investors believed that internet-based businesses would succeed simply because the internet was a groundbreaking innovation, even though tech stock prices soared far beyond their actual value.
This narrow investing approach prevented investors from seeing the warning signs that eventually led to the bubble’s burst.
Which Companies Thrived After the Dot-Com Crash?
While numerous tech companies didn’t make it through the dot-com bubble burst, some managed to weather the storm and make a comeback in the years that followed. According to the New York Times, around 48% of the companies caught up in the bubble’s frenzy survived the crash, although many did experience significant temporary declines in their value. Here are a few examples of companies that not only survived the challenging tech boom but also achieved long-term success.
Amazon
Amazon had a rocky ride during the dot-com bubble. Initially founded as an online bookstore in 1994, the company diversified its offerings to become the world’s largest online retailer. Its IPO in 1997 was priced at $18.00 per share, but during the dot-com bubble, its stock price soared to $107.00 per share. However, like many dot-com companies at the time, Amazon wasn’t focused on profitability.
When the bubble burst, Amazon’s stock price plummeted to just under $7.00 per share. But Amazon didn’t give up. It shifted its focus to the fundamentals, and in 2003, it reported its first annual profit of $35.3 million, a significant turnaround from a loss of $149.1 million in 2002. Today, Amazon remains one of the most valuable and successful companies globally. It survived and went on to become one of the world’s largest and most successful e-commerce and technology companies.
eBay
Founded in 1995, eBay started as an online auction platform around the same time as Amazon. The company experienced rapid growth and went public in September 1998 with an IPO price of just $18 per share, which nearly tripled to $53 on the first day of trading. Unlike many other dot-com companies, eBay managed to avoid the worst of the bubble’s collapse, partly because its online auction concept continued to gain popularity even as other businesses faltered.
eBay, Inc. is now the world’s leading online auction and retail website. In its early days, it saw impressive growth, with visitor numbers climbing from 250,000 in 1996 to two million by January 1997. Despite a hit during the dot-com downturn, eBay bounced back and not only survived but thrived. It established itself as a popular online marketplace and auction platform and continued to grow throughout and after the bubble burst.
Priceline
Priceline was founded in 1998, just before the dot-com bubble burst. Priceline’s story was typical of internet stocks of that time. The company went public just a year after it was founded and saw its initial stock price jump from $16 to over $86.00. Like Amazon.com, the company saw its stock price crash to under $10. One of the changes that has helped Priceline.com survive and even thrive is the fact that the company’s business model was retooled in the early 2000s to focus more on hotels than airfare.
In addition to the dot-com failure in 2000, Priceline.com’s share price faced additional pressure after the September 11, 2001, terrorist attacks decimated the entire travel industry. In the aftermath, Priceline.com rebranded itself around hotels, not airfares, and expanded its presence internationally. The strategy worked. Priceline.com’s share price trades for more than $1750 per share. It expanded its services to include various travel-related platforms under the parent company Booking Holdings.
Cisco Systems
Cisco, a networking equipment company, was founded in 1984 but experienced significant growth during the dot-com boom as the internet expanded. Its stock price surged from $8 to $80 in just three years. Although its stock price declined after the bubble burst, Cisco remained a dominant player in the networking industry. Cisco navigated the crash successfully by diversifying its business and acquiring new companies.
Founded in 1998, Google is one of the most iconic companies to emerge from the dot-com era. It started as a search engine but expanded into various other products and services, becoming a dominant force in online advertising, cloud computing, and mobile technology. Its 2004 IPO was a resounding success, and since then, the company has continued to expand and diversify its offerings.
Netflix
Founded in 1997, Netflix initially began as a DVD-by-mail rental service. It may be difficult to believe today, but at the beginning of the 2000s, Netflix was in a struggle for relevance. In 2000, the company incurred losses of over $50 million, had difficulty reaching 300,000 subscribers and had to shelve its plans for an initial public offering due to the dot-com bubble’s collapse. Seeking assistance, Netflix turned to an unexpected ally: Blockbuster. But we all know how that story panned out.
It successfully transitioned to online streaming in the mid-2000s and is now one of the leading global streaming entertainment services.
Yahoo
Yahoo! was founded in 1994 as a web directory and search engine, later expanding into email, news, and more. During the dot-com bubble, Yahoo! ‘s stock price jumped from $2 to $120 in a mere two years. However, the company faced challenges in adapting to new technologies and was eventually surpassed by Google. Nonetheless, Yahoo! remains a significant presence in the internet industry today.
