The Dot-Com Bubble

In the late 1990s, excitement about the internet sent technology stocks to extraordinary valuations. Companies with little revenue and no profits went public and doubled on their first day. The Nasdaq Composite, home to many technology stocks, rose about fivefold in five years, peaking in March 2000. Over the next two and a half years it fell about 78%, wiping out trillions of dollars of market value. The internet did change the world, but most dot com companies did not survive, and investors learned again that a great technology is not the same as a great investment at any price.

Timeline#

Causes#

Valuations at the peak#

Many leading technology stocks traded at price to earnings ratios above 100, and some companies with no earnings were valued in the billions. The S&P 500's cyclically adjusted price to earnings ratio reached its highest level on record, above its 1929 peak. See P/E and Forward P/E.

Winners and losers#

Some companies founded or growing in the period, such as Amazon, survived and became giants, though Amazon's stock itself fell more than 90% from its 1999 peak to its 2001 low. Many others, such as Pets.com, Webvan and eToys, went bankrupt. Telecom companies that borrowed heavily to build networks also collapsed, and accounting scandals such as Enron and WorldCom emerged as the boom ended, leading to the Sarbanes Oxley Act of 2002. See Earnings Quality and Cash Conversion.

Warning signs#

1. Valuations justified by "this time is different" rather than cash flows. See DCF Valuation.
2. Profitless companies with soaring share prices.
3. Record IPO activity and huge first day gains.
4. Widespread retail speculation and stories of easy riches.
5. Rising rates after a long period of easy money.

Lessons for investors#

• Price matters: a good business can be a bad investment at too high a price.
• Survivorship bias: remembering Amazon hides the hundreds of failures. See Survivorship and Selection Bias.
• Diversify: concentrated technology portfolios suffered the most. See Concentration Risk.
• Be wary of narratives: recent gains make extrapolation tempting. See Recency Bias.
• Drawdowns can last years, so position size and time horizon matter. See Position Sizing.

Frequently asked questions#

What was the dot com bubble?#

A speculative boom in internet related stocks in the late 1990s, followed by a crash from 2000 to 2002 in which the Nasdaq lost about 78%.

What caused the dot com crash?#

Extreme valuations, profitless companies running out of funding, rising interest rates and a recession ended the boom.

How long did the Nasdaq take to recover?#

The Nasdaq Composite did not surpass its March 2000 peak until April 2015, about 15 years later.

Next, learn about the worst financial crisis since the Depression in The 2008 Financial Crisis.