dot-com bubble

dot-com bubble, period (1995–2000) of large, rapid, and ultimately unsustainable increases in the valuation of stock market shares in Internet service and technology companies, then commonly referred to as “dot-com” companies, including fledgling businesses, or “start-ups,” with little or no record of profitability or with unrealistic business models. During the dot-com bubble, the technology-dominated NASDAQ Composite index (a representation of the total value of the outstanding shares of companies listed in the NASDAQ stock exchange) rose nearly sevenfold, from 743 to 5,048, reflecting the early enthusiasm of investors in dot-com enterprises and the willingness of venture capitalists to finance the initial public offerings (IPOs) of Internet start-ups, many of whose share prices then skyrocketed. Indeed, many start-up employees who were initially compensated with stock options quickly became millionaires once their companies went public.

As the valuations of shares in new and existing dot-com companies continued to rise, many investors became convinced that the U.S. economy had been fundamentally transformed and that several factors that had traditionally figured in the valuation of a company’s shares—such as current assets, debts, revenues, profit margins, market share, and cash flow—were not directly relevant to assessing the future performance of dot-com companies, particularly start-ups. Accordingly, investors continued to pour money even into debt-ridden companies that had no realistic hope of ever turning a profit. Such investor overconfidence (often referred to as “irrational exuberance”) led the shares of dot-com companies to be priced far in excess of the values that traditional assessment factors would have justified.

As do all financial bubbles, the dot-com bubble finally burst. In early 2000, after the U.S. Federal Reserve announced a modest increase in interest rates to stave off inflationary pressures—a move that would necessarily reduce investment capital by making borrowing more expensive—investors in dot-com companies began a panicked sell-off of their holdings. Between March 2000 and October 2002, the NASDAQ fell from 5,048 to 1,139, erasing nearly all of its gains during the dot-com bubble. By the end of 2001, most publicly traded dot-com companies had failed.