What Was the Dotcom Bubble?

The Dotcom Bubble Explained

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The dotcom bubble was the huge overvaluation of internet-based companies between 1995 and 2000. When that bubble burst, the stock price of those companies crashed and the broader stock market crashed, as well. 

At the close of the 20th century, retail and services on the internet was the new, big thing. A new era was underway and the old rules didn’t apply—until it turned out that they did. Very few of the dot.com companies were profitable. Learn how investors found out, the hard way, that ignoring fundamentals is foolhardy. 

Definition of the Dotcom Bubble

The dotcom bubble saw internet-based and technology companies with little track record, receive extremely high valuations, beginning in the late 1990s. Not only did that see huge jumps in the stock prices of these companies, but also the benchmark Nasdaq Composite Index also rose swiftly. This trend continued until the bubble burst in 2000, when the markets crashed, stock prices of those companies collapsed, and many of them went out of business.

Alternate names: internet bubble, information technology bubble. 

The dotcom bubble was a worldwide phenomenon, although most of the dotcoms involved were U.S.-based. The most notorious included Pets.com, e-toys.com, Boo.com and Webvan.com. 

“Dotcom” was a new term back in the 1990s. It referred to .com, the URL designation of commercial enterprises on the internet.  

Initial public offerings (IPOs) flourished before the dotcom bubble burst. That was how venture capitalists made their money. Many of these venture capitalists had little retail experience and backed companies that didn’t have proven business models. At its peak, the companies going public raised a great deal of money, although they never made a profit. 

Bubbles, however, are as old as modern finance. The first recorded bubble, dubbed tulip mania, took place in the 17th century due to speculation in tulip futures. In February 1637, that bubble burst, and fortunes were lost as tulip future contract prices collapsed. 

Although it occurred nearly 360 years later, the speculation and frenzy surrounding dotcom stocks would have been familiar to those Dutch tulip speculators.

What Happened During the Dotcom Bubble?

As the bubble expanded, the Nasdaq Composite Index tripled in value in the year and a half prior to reaching its peak in March 2000. That was also a period when many people did quit their day jobs to become day traders. Margin lending rose considerably. Speculation soared, and day traders were responsible for much of that activity.

However, the dotcom drop was swift. By the end of the year, the Nasdaq dropped nearly 55% and almost $5 trillion in value evaporated from the stock markets.  The Nasdaq would not reach its previous high for another 15 years.

Priceline is a good example of a company that was impacted by the dotcom bubble. Its business model was to match unsold airline tickets to customers at a discount. Everyone benefited. The airline got rid of unused inventory, customers got a bargain, and Priceline took its cut.  

But the model also meant that the company had to purchase open market tickets, at full freight, even though its customers placed low bids. Money was lost on most tickets. It also turned out that customers often could have done better placing their reservations via a travel agency.

Priceline’s IPO in March 1999 saw shares going public at $16 per share, quickly ramping up to $88 on the first day of trading before ending the day at $69. With a market capitalization, or total value of its stock shares, of $9.8 billion, Priceline boasted the largest initial day internet company valuation at that time.

When the bubble burst, Priceline lost 94%of its value. Priceline, however, did not join the list of dot.com casualties. It survives today as Booking Holdings. Others such as Webvan, an online grocery service, perished after filing for bankruptcy in 2001.

Can the Dotcom Bubble Happen Again?

While 2021 saw dramatic swings in stock prices of technology stocks, it is not 2000 anymore. Then, the companies in question were startups with no proven track record. Today, many of these tech companies are mature.

According to Pew Research Center, in the early 2000s almost half of American adults were online, that figure is 93% in 2021.

The booming companies, such as Facebook, Amazon, Apple, Netflix and Google also known as the FAANGs, focus on the digital world more than the physical one. These companies are so large that a movement of their stock prices impacts the entire market.

Facebook was not founded until 2004, after the dotcom crash. Google was not yet a public company at the time. Apple was simply making Macs back then, its suite of products still in the future. Apple is now worth more than $2 trillion, the largest valuation ever reached by a U.S. company.

Michael Kuczinski,president of Total Wealth Enhancement, LLC believes that there will be another market crash, with only questions about “when will it hit, how deep will it go and how long will it last.”

Kuczinski told The Balance in an email that there are some similarities between the markets today and those in the dotcom era, especially on account of over exuberance, high margin balances, significantly higher stock to bond ratios for otherwise risk averse investors, and high valuations for  companies with no earnings and/or little or no revenue.

But what’s different this time, according to Kuczinski, is that he doesn’t think that the next bear market will be prompted solely by the failure of so many of these types of companies as it was in 2000-2002. Instead, it is more likely to occur due to a broader decline in the markets prompted by declining fundamentals in the overall economy. 

Scott Seymour founded his wealth management firm Great Scott Financial, in 1998, as the dotcom bubble took shape and saw some of his clients get affected. He, too, thinks such a bubble could happen again. This time around, he sees meme stocks and apps like Robinhood fueling fervent speculation. 

What the Dotcom Bubble Meant for Individual Investors 

The dotcom bubble taught individual investors some harsh lessons. Individual investors fueled the dotcom bubble as insiders at dotcom companies were cashing in. 

As rough as the dotcom bubble period was, it was relatively mild compared to the housing bubble that followed a few years later. 

In 2003, in a speech before the National Press Club, Securities and Exchange Commission chairman William H. Donaldson summed up what happened during the dotcom bubble. He noted that the 1990s saw revolutions in information technology and communications, with the internet changing the ways people not only did business but lived their lives. These changes also brought millions of people into the stock market for the first time. 

“Starting in the second quarter of 2000, the bubble burst. Stock prices plummeted. Investors fled the markets. And the IPO market disappeared,” said Donaldson, adding that it was soon apparent the boom years were accompanied “by a serious erosion of business principles.” 

Another dotcom bubble per se may not happen again. However, the odds are good that another asset bubble of some type could explode. But there are some signs you can watch out for.

Long-term investment strategist and Co-founder of Boston-based asset management firm Grantham, Mayo, & van Otterloo (GMO) Jeremy Grantham, often described as a “bubble expert” in financial media, believes that the “long, long bull market since 2009 has finally matured into a fully-fledged epic bubble.” 

Writing market commentary in January 2021, Grantham explained that nearly 75% of the time major asset classes are priced relative to each other. Trouble starts in those periods when asset prices do not correspond to fair value. “The single most dependable feature of the late stages of the great bubbles of history has been really crazy investor behavior, especially on the part of individuals,” Grantham wrote.

Key Takeaways

  • The dotcom bubble between 1995 and 2001 saw internet companies with little or no revenues receive extremely high valuations.
  • A lot of internet and technology companies raised funds through IPOs.
  • The Nasdaq Composite Index tripled in 18 months till March 2000 before losing over 50% by the end of the year.
  • When the bubble burst in 2000, nearly $5 trillion in stock valuations disappeared.