Dot-Com Bubble
What is Dot-Com Bubble?
The dot-com bubble was the surge in internet company share prices during the late 1990s, followed by a crash when the promised profits never came.
During the late 1990s investors bid up the shares of internet companies far beyond what their earnings could justify, and the Nasdaq index went on to lose roughly three quarters of its value from the peak. A share is worth the present value of the cash it is expected to pay out, so a bubble exists when the price is driven instead by the belief that someone else will pay more tomorrow. Cheap capital, real excitement about a new technology, and measures such as page views standing in for profits let firms with no earnings command enormous valuations. When the expected profits did not arrive, the belief reversed and prices fell fast. The bust destroyed wealth and cut business investment, but because the losses sat with equity holders rather than borrowed money inside banks, the recession that followed was mild compared with the housing crash a decade later.
Dot-Com Bubble: a worked example
Imagine a young online retailer with no profits priced at $2 billion because investors expect it to earn $200 million a year before long. Suppose the business turns out to have a durable profit of only $20 million a year. At a 10 percent required return, that stream is worth $20 million ÷ 0.10 = $200 million, one tenth of the price investors paid. Nothing about the company had to fail for the shares to lose 90 percent of their value; the earnings forecast simply had to come back to earth. Multiply that across hundreds of listed firms and you have the crash.
The mistake students make with dot-com bubble
Students often think a bubble means the technology was fake. The internet was real and reshaped the economy; what was wrong was the price, not the invention, and several surviving firms grew into the profits investors had imagined too early. The second mistake is assuming every asset crash causes a deep recession. This one hit diversified shareholders rather than the balance sheets of banks, so the damage stayed contained.
Dot-Com Bubble questions
What caused the dot-com bubble to burst?
The dot-com bubble burst when investors stopped believing that loss-making internet firms would grow into their valuations, so prices fell back toward the value of actual earnings. Rising interest rates and a run of disappointing results made the reckoning sharper. Once the expectation of reselling at a higher price disappeared, the reason to hold the shares disappeared with it.
How is a bubble different from a normal price increase?
A bubble is a price rise driven by expected resale gains rather than by expected future earnings, which is what makes it fragile. Prices can rise a long way for sound reasons when profits or demand genuinely improve. The test is whether the price can be justified by any reasonable forecast of the cash the asset will produce.
Why was the dot-com crash less damaging than the housing crash?
The dot-com crash destroyed share wealth held mostly by investors who could absorb the loss, while the housing crash destroyed the capital of heavily borrowed banks and households. When lenders themselves become insolvent, credit stops flowing to everyone, which turns an asset loss into an economy-wide contraction. That transmission channel was largely missing after the technology bust.
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