Dot-Com Bubble

Context/Description: The commercialization of the Internet in the mid-1990s created revolutionary possibilities for business, communication, and commerce. Venture capital flooded into Internet startups with any ".com" in their name. The Nasdaq Composite index rose approximately 400% from 1995 to its March 2000 peak. Companies went public through IPOs with minimal revenue, no profits, and business plans focused on "getting big fast" and capturing "eyeballs" (user attention) rather than generating earnings. Traditional valuation metrics were dismissed as outdated—"old economy" thinking.

Warning Signs:

• Absurd valuations: Companies with no revenue trading at billion-dollar market caps
• Price-to-sales ratios exceeding 100x (when traditional stocks were at 1-3x)
• "Burn rate" celebrated: Companies spending faster seen as more aggressive/successful
• Super Bowl ads from startups no one had heard of
• Federal Reserve raising interest rates 6 times from June 1999-May 2000
• Insider selling at peaks
• IPO mania: Companies going public within months of founding
• "Irrational exuberance" (Alan Greenspan's famous 1996 warning gaining relevance)
• Pets.com, Webvan, Kozmo—companies with business models that clearly lost money per transaction

The Problem: Speculation completely disconnected from fundamentals. Many companies had no path to profitability—they were burning through capital without viable revenue models. The "network effects" and "first-mover advantage" theories were real but overestimated. Investors assumed someone would eventually buy their overpriced shares. Traditional metrics (P/E ratios, cash flow, profitability) were ignored.

The Trigger: Multiple factors converged in early 2000:

• Federal Reserve rate hikes to cool the economy cooled it too much
• Microsoft antitrust ruling (April 2000) hurt tech sentiment
• Several high-profile IPO failures
• Analysts began questioning valuations
• Lock-up periods expired, allowing insiders to sell

On March 10, 2000, the Nasdaq peaked at 5,048. The crash began almost immediately.

The Cascade:

• Initial decline triggered margin calls and forced selling
• One by one, unprofitable companies ran out of cash and failed
• Venture capital dried up—no funding for additional losses
• Advertising revenue (many sites' only income) collapsed
• High-profile bankruptcies: Pets.com (spent $300M in 2 years), Webvan ($1B lost), hundreds more
• Telecommunications overcapacity from "build it and they will come" infrastructure spending
• Tech employment collapsed; Silicon Valley commercial real estate crashed

Results/Impacts:

• Nasdaq fell 78% from peak to October 2002 trough (5,048 to 1,114)
• Approximately $5 trillion in market value destroyed
• Thousands of companies bankrupt
• 2001 recession: U.S. GDP contracted 2.5%
• Tech sector mass layoffs: Hundreds of thousands lost jobs
• 401(k) retirement accounts devastated for many near retirement
• Broader market decline: S&P 500 fell nearly 50%

Regulatory Response:

• Sarbanes-Oxley Act (2002): Stricter accounting standards, CEO/CFO certification of financials, auditor independence
• Increased SEC scrutiny of IPOs and analyst conflicts of interest
• Criminal prosecutions for accounting fraud (Enron, WorldCom—partly related to bubble mentality)

Long-Term Effects:

• Venture capital became more disciplined, demanding paths to profitability
• "Fundamentals matter" returned to investment thinking
• However, valuable companies and technologies emerged: Amazon, eBay, Google
• Infrastructure built during boom enabled future innovation

The Lesson: Revolutionary technology doesn't exempt companies from needing profitable business models. "This time is different" is almost never true. Momentum investing works until it catastrophically doesn't. However, bubbles can fund infrastructure and innovation that pays off long-term, even if most companies fail.