Dotcom Bubble

The dotcom bubble was a time when many technology startups began to appear.

Author: Matthew Retzloff
Matthew Retzloff
Matthew Retzloff
Investment Banking | Corporate Development

Matthew started his finance career working as an investment banking analyst for Falcon Capital Partners, a healthcare IT boutique, before moving on to work for Raymond James Financial, Inc in their specialty finance coverage group in Atlanta. Matthew then started in a role in corporate development at Babcock & Wilcox before moving to a corporate development associate role with Caesars Entertainment Corporation where he currently is. Matthew provides support to Caesars' M&A processes including evaluating inbound teasers/CIMs to identify possible acquisition targets, due diligence, constructing financial models, corporate valuation, and interacting with potential acquisition targets.

Matthew has a Bachelor of Science in Accounting and Business Administration and a Bachelor of Arts in German from University of North Carolina.

Reviewed By: Elliot Meade
Elliot Meade
Elliot Meade
Private Equity | Investment Banking

Elliot currently works as a Private Equity Associate at Greenridge Investment Partners, a middle market fund based in Austin, TX. He was previously an Analyst in Piper Jaffray's Leveraged Finance group, working across all industry verticals on LBOs, acquisition financings, refinancings, and recapitalizations. Prior to Piper Jaffray, he spent 2 years at Citi in the Leveraged Finance Credit Portfolio group focused on origination and ongoing credit monitoring of outstanding loans and was also a member of the Columbia recruiting committee for the Investment Banking Division for incoming summer and full-time analysts.

Elliot has a Bachelor of Arts in Business Management from Columbia University.

Last Updated:December 8, 2023

What is the Dotcom Bubble?

The dotcom bubble was a time when many technology startups began to appear. However, unlike the large and reputable companies such as Intel, Cisco, and Oracle, the startups were not strong, and when capital dried up, so did their business.

During the bull market of the 1990s, investment firms invested in these startups with high valuations. Although most tech startups barely had business plans or a sense of structure, their strong valuations pushed the equity markets extremely high. 

However, once the technology firms were not performing well and the investors ran out of capital, the bubble began to burst. This left the equity markets falling, which saw an almost 77% drop after climbing five times what it was at the beginning of 1995. 

A significant cause of the bubble was the abundance of speculative and fad-based investing. This, in combination with many venture capital firms investing in startup companies that could not produce a profit, caused the giant bubble to burst.  

Many left their cautious investing behind during this span.

The years between 1995 and 1997 were considered when the pre-bubble started to heat up. Then, 1998-2000 are considered when the bubble was in effect when startups displayed little fiscal responsibility.

Investors during this time were not using the cautious strategies they should have. Instead, they were irresponsibly throwing money at the technology firms that would never be able to give them a return on investment

They did this because they thought they would miss a significant return with the tech frenzy. 

Years before the bursting of the dotcom bubble, the United States was already witnessing low-interest record rates. That said, there was a lot of interest in the internet, and investors saw an opportunity to invest in such companies even though they had no track record. 

How the Dotcom Bubble Burst

In the years leading up to and during the 1990s, there was accelerated technological growth, and the internet was the largest. Although hard to believe, the internet has only been available to the public for about thirty years and has since become much more sophisticated. 

During the years leading up to the bubble, money was cheap, interest rates were low, and investment firms were undoubtedly taking advantage of the situation. However, there was also a concerning amount of overconfidence in the market and speculation. 

Some companies failed when the bubble ended up bursting. For example, some companies were trying to grow an online audience with retail stores such as pets.com. There were also communication companies that failed, such as Worldcom

  • Companies such as pets.com failed because their business plans needed to be revised.
  • For example, they were a little too early for their time, meaning people wanted to avoid buying their pet supplies and wait for them to be delivered when they could go to the store and get them the same day. 
  • This caused the company to have nine straight months of losses, and it decided to sell its assets before many more losses were incurred.
  • Many questioned how they were able to get an IPO when they had a skeptical business plan in the first place. 

Although, they were able to pay back investors what they could by using the revenues from the first sale. This is just one example of a company going under. In this example, investors could get some of their money back, but not all of it. 

Investors during this time did not seem to care about speculative business plans. They would instead take the risk of the company going under than think they missed the chance to get in early on the dot-com boom. If only they had known.

What was needed was to wait and undertake a detailed valuation of the company to find out what it was truly worth. If they had done this, they would have found that most of the companies they were interested in would have already gone under before considering investing in it. 

Dotcom Bubble Effects

There were many effects on the economy and society due to the burst of the dotcom bubble, and the greatest was that it sent the economy into a recession. However, the bubble produced a rise in the stock market like never before. 

Before the bubble burst, the markets were soaring. The stock market had grown fivefold from 1995 to 2000, and the internet was to thank for that. These tech company stocks made up over twenty percent of all publicly traded equity volume in the U.S during those two years.

Three terms describe a market bubble:

  • pre-bubble,
  • bubble, and
  • the bubble burst.

These terms describe the time or stage the bubble is in. 

The pre-bubble lasted from 1995-1997, and the bubble lasted from 1998-2000. Finally, the bubble burst lasted from March 2000 until October 2002. 

During this time, there was a challenging economic downturn, which led to pushing the economy into a recession. However, the recession was very mild, inflation remained low, but the Federal Reserve raised rates. 

The economic expansion from 2001-2007 following the “Dot-Bomb” Recession has been one of the weakest since World War II. Although the housing market was on the rise in the early 2000s, most know that it ended in 2008 due to the housing bubble burst. 

How to Avoid Another Bubble

To avoid another bubble, we can take a few actions to prevent such an event. These actions include:

  1. Remove “investment of expectation”: Investors should avoid investing in companies that are yet to prove themselves. This means avoiding companies yet to see profit or prove stable in the long run. 
  2. Undertake due diligence: Before investing in new startup companies, investors must complete their due diligence. One can do this by ensuring their core values are desirable,   ensuring their business models make sense, and their operations do not have any apparent detrimental flaws.
  3. Staying away from companies with a high beta: Companies with a beta greater than one will likely be hurt worse than companies with a lower beta during a recession. Therefore, investors should keep away from such companies. 
  4. Avoid being pulled into market overconfidence: During a pre-bubble, there will be a point when everyone shifts their thinking and believes that the perfect investment time is then and there. If investors can avoid digging into this confidence and be patient, they may prevent a full-on bubble. 
  5. Diversifying your portfolio: Time and time, it has been proven that an investor with good diversification in their portfolio has less risk in bubbles and the recessions that follow. 

Conclusion

The dotcom bubble was between 1995 and 2000 when technology and internet-based companies were extremely overvalued. As a result, investors wasted no time throwing money at these companies because they wanted to take advantage of the opportunity and be on time for the party. 

In the years leading up to the bubble, interest rates were extremely low, which allowed startup companies to borrow money cheaply and fund their companies. But unfortunately, there was too much confidence in the market, which led to the overvaluation of companies. 

Later in the bubble, the new startup companies that people were heavily invested in could not show a substantial amount of revenue, much less proof of turning a profit. This left these companies running on little to no capital, eventually failing. 

Once the bubble burst, many investors were still waiting for a return or money. This left the market in a recession. However, the recession during those years was mild and did not tear the economy apart. As a result, inflation was not high, and unemployment was not beaten down.

Apart from inflation and unemployment, the markets took a brutal downturn that led to a bear market. Many investors did not believe that the price of companies could ever come down after they were up fivefold from 1995 to 2000; obviously, this was different. 

Dotcom Bubble FAQs

Researched and authored by Adam Bridges | Linkedin

Reviewed and Edited by Krupa Jatania I LinkedIn

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