What was the Dot-Com Bubble?

The emergence of the internet resulted in many businesses popping up during the 1990s, which were known as dot-com companies. The world had high hopes for these businesses, but those hopes were short lived when the dot-com bubble popped during the early 2000s. During this time, we saw the rise and fall of tech stocks, meaning many businesses went bust and investors lost their money.

What was the Dot-Com Bubble?

In the late 90s, the internet became more pervasive in homes thanks to web browsers, among other factors. In response to this, there was an uptick in tech and internet service businesses and investors had high hopes for these companies. Investors and venture capitalists poured money into these dot-com businesses and these companies experienced exponential growth in the valuation of their stock market shares. While this meant many businesses and employee shares skyrocketed overnight, it also created a ‘bubble’ in the market, which is popularly known as the dot-com bubble. During the late 90s and early 2000s, the bubble busted and resulted in one of the biggest market crashes in history.

Causes of the Dot-Com Crash

Three major things that caused the dot-com bust include the dot-com company’s lack of profitability, over funding from venture capitalists and speculative investing by investors.

The problem with many tech businesses during this era is they had no track record of success as it relates to profitability, and they didn’t have reliable business models. Nonetheless, these companies got investment funds from venture capitalists enthusiastic about investing in their initial public offerings or IPOs. This coupled with funding from hopeful investors and financing from banks at relatively low interest rates led to overvalued companies.

When did the dot-com bubble burst? One catalyst was in early 2000, the Federal Reserve announced an increase in interest rates to address inflation at the time. Consequently, borrowing became more expensive, investors panicked and many sold investments they had in dot-com companies. Generally, during periods of high inflation, investors tend to move towards safer investments like bonds or CDs and opt out of riskier and more speculative investments. It is also believed that news of Japan’s recession in 2000 had a ripple effect on the U.S. and led to investor fear and panic market withdrawals.

While the mentioned may have been catalysts of the dot-com market crash, a primary cause was investors ignoring steps that should be taken before investing in a company. One is assessing how valuable a company is before pouring money into it. Key metrics often used in assessing a stock’s value include the number of assets it holds, debt, revenue, profit margins, market share, and cash flow. Turning a blind eye to companies with robust amounts of debt may also have led to companies being overvalued and the bust of the bubble.

The dot-com crash had such a detrimental effect on the market that between March 2000 and October 2002, the NASDAQ fell from 5,048 to 1,139. Many of the dot-com companies went bust by 2001. The bursting of the dot-com bubble birthed a bear market and affected the entire market for about two years after. Some companies that closed their doors include entities like pets.co and eToys. There were a few renowned companies able to withstand the market crash such as Amazon, Adobe Systems, eBay and Intuit.

A key lesson investors can learn from the dot-com crash is the importance of doing research before investing. Due diligence includes vetting a company to see how profitable it is and gauging a company’s growth potential. One way to do this is by checking a company’s profit to earnings ratio among other strategies.