Fueled by investments in companies based on the Internet, the dot com bubble, also known as the internet bubble, was a rapid rise in U.S. technology stock equity valuations during the bull market in the late 1990’s.
The bubble grew out of a fad based and speculative investing, the abundance of venture capital for startups and ultimately and unfortunately, the failure of these tech stocks to generate profits. In the hope that internet startups would be the next big thing and would, one day, reap high returns, the investors backed them with all they had. Some of them even abandoned a justified approach for making investments on account of the fast-growing pace of the internet.
With capital markets out there as a potential source of investment to avoid idle cash, startups were in a race to prove their worth. Companies would spend nearly 90% of their budget on advertising and promotion to build credibility and differentiate themselves from others. As a consequence, important areas that required allocation of funds, like research and development, went unnoticed and the management lost track of the fiscal responsibility that rested on their shoulders as well.
The injection of funds in Nasdaq in 1997 was hitting an all-time high. By 1999, 39% of all investments by venture capitalists flowed into internet companies. As a result, 295 of 457 Initial Public Offers were related to internet companies which further increased to 91% in the first quarter of 2000 alone.
The high water mark was the megamerger between America Online and Time Warner which is now the biggest merger failure in history.
The then-Fed Chairman, Alan Greenspan, had already warned the markets about their excessive and irrational exuberance but he did not strictly regulate the monetary policy until the spring of 2000. By which time banks and broker houses had already crossed and utilized the liquidity that was created in advance of the Y2K Bug, also called the Year 2000 bug or Millennium Bug, that created havoc in the coding computerized systems network around the world, to finance the internet stocks.
Even though it was a period of rapid technological advancement in diverse areas, the 1990’s was the period when the greatest expansion in capital investment was witnessed and its growth was largely dominated by the internet. Although there were some legitimate players in the market like Intel, Cisco and Oracle which were the high tech standard-bearers, what fueled the stock market surge was the dot-com companies in 1995.
Fed by easy capital, cheap money, market overconfidence, and pure speculation, the dot com bubble steadily approached its end. Venture capitalists were so excited that they would invest in any company with a ‘.com’ in the end, basically succumbing to the trends. Willing to oversee and ignore the traditional business fundamentals, the investors valued the firm based on their estimated or initial earning and profits which would clearly not be so lucrative after several years. Those companies that faced difficulty in the markets, went ahead for the IPOs and witnessed their prices triple or even quadruple in one day.
During the time when the dot com bubble was growing, the NASDAQ index was rising from under 1,000 to more than 5,000 between 1995 and 2000. The NASDAQ jumped to 5048 points on March 10, 2000, which was nearly double that in the previous year. Right at the peak, several big players placed huge sell orders on their stocks which incited mass panic selling among investors leading to a much obvious decline in the prices. Within a couple of weeks, the stock market was at 90%.
With a parallel (yet unparalleled) decline in the prices and the demand, the capital began to dry up and so did the lifeblood of all the cash strapped dot com companies. Within a matter of months, tech companies went from rags to riches and then from riches to rags, just like a rollercoaster ride. By the end of 2001, trillions of dollars of investment capital were evaporated, and the publicly listed dotcom companies that were trading had to wrap up. The NASDAQ index stumbled to 1139 in October 2000, a fall of 76.81%. The share prices of even the blue-chips were down to 20%. It was just like gasoline on the fire, and hence, the dot com bubble had to burst.