Between 1995 and 2,000, many investors were keen to get in on the rapidly developing internet technology sector, and new companies were set up and funded on a daily basis. The period has become known as the “Dot-com bubble.” On March 29th, 1999, the Dow Jones Index passed 10,000 for the first time in history. Initial Public Offerings attracted huge sums, with successful launches for Netscape, Yahoo and Lycos hitting the headlines and spurring investors into backing other startups.
The bubble was fed by low interest rates (cheap money) and market exuberance. Anything with a “.com” after its name was thought promising, and people didn’t want to miss out on the future. Most such companies offered free services and had no earnings, but investors expected them to generate profits in the future, and ignored traditional measures such as the price-earnings ratio. I had one friend who spent huge sums building up such a company, talking about the value of his ‘lists’ of addresses, but without any means of commercializing them. It was typical of the “growth over profits” approach that characterized such enterprises.
The bubble burst, of course. Alan Greenspan raised interest rates, and companies that had borrowed heavily found themselves insolvent. When Barron’s ran a cover story in March 2000, entitled "Burning Up; Warning: Internet companies are running out of cash – fast," alarm bells rang and investors rethought their approach. Many big-name companies, including ones that had been valued in billions at recent IPOs, went broke and folded. In 2 years the Nasdaq dropped nearly 80%. Amazon and e-Bay survived, but most didn’t.
It was by no means the first such bubble, and will not be the last. Among the famous ones are the tulip mania in the Netherlands from 1634-1637, in which single bulbs were selling at one stage for the price of a house.
The South Sea Bubble (1716-1720) was in the shares of the South Sea Company, given special trading rights in South America by the British government. Speculation and rumour vastly overstated any actual potential.
The British Railway Mania of the 1840s was an earlier case of over-exuberance toward the business prospects of a new and disruptive technology.
The 1929 US Stock Market Crash came after a period of peace and prosperity sent share prices rocketing as new technologies, such as radio, motor cars and aeroplanes, were making a commercial impact.
The common factors underlying most bubbles seem to be an over-exuberance toward something new, rather than a cold calculation of its likely potential. It happens because it is very difficult to evaluate the likely impact of innovations. They take us sailing into new and uncharted waters, with optimism filling the sails. The only antidote to this exuberance is realism, and the hard calculations about cash flows and likely returns.