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Lessons from past: The dot com bubble - Views on News from Equitymaster
 
 
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  • Mar 18, 2009

    Lessons from past: The dot com bubble

    In the previous article we have discussed about 'The Florida real estate bubble' which started in the early 1920s, when Florida entered a period of frenzied real estate speculation. The bubble lasted for almost a decade and ended as the Great Depression began. Today we will discuss about the bubble that arose around the turn of the millennium - the dot com bubble.

    The dot com bubble
    The mid 1990s marked the beginning of a major growth of Internet users, who were viewed by companies as potential consumers. This prompted several entrepreneurs to venture into internet start-ups. These start ups came to be known as 'dot coms', as most of these companies had .com in their web addresses. At the pinnacle of the bubble many companies got engaged in unusual and risky business practices with the hopes of dominating their respective markets. Most of these dot com companies followed a policy of growth over profit. They assumed that if they built up their customer base, their profits would eventually rise. Investors responded to these risky business ventures with pots of money. With hundreds of companies being founded in a very short span of time, especially in tech hot spots like the Silicon Valley, the tech laden index NASDAQ rose dramatically during this time.

    The euphoria was backed by the belief that internet business somehow would instantly take off and the entire business landscape will change in a very short span of time. However, no fundamental change was actually happening at the ground level. It was just wishful thinking on the part of companies that had no realistic business model to get these ideas off the ground.

    The hype didn't live up to its promises. Numerous high profile court cases regarding unscrupulous business practices started cropping up and the stock market began to tumble down. Unfortunately, the growth of the tech sector proved to be illusionary and dot com bubble burst in the year 2001. A decline in business spending combined with the market correction dealt a serious financial blow to many dot-com companies.

    Conclusion
    The internet caught the fancy of people in the 1990's. This prompted many companies to promise life-altering changes. Though these ideas for change had a grain of truth in them, they were expected to deliver overnight instead of the decades they would actually require. The fundamentals of the dot com bubble were terrible. Most of the companies were not profitable and were having very risky business models. Some of them had no intention of ever making a profit. While the business model of these companies had no realistic way to turn a profit, their IPOs were skyrocketing just because of hype around them.

    The burst of dotcom bubble once again highlighted the fact that the performance of a stock is dependent on performance of the company. As Peter Lynch says "I think you have to learn that there's a company behind every stock, and that there's only one real reason why stocks go up. Companies go from doing poorly to doing well or small companies grow to large companies."

     

     

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