By Gustav Andersson
Learning from the Past: How the Dotcom Bubble Changed the Tech Industry
Between 1995-2000, the dotcom stocks’ valuation was in a speculative frenzy, with rapid growth and high valuations. The focus was entirely on potential and dreams rather than proven success. The truth is some companies achieved billion-dollar valuations quickly based on potential, even though they had solid and legitimate business plans and innovative ideas. Investors poured money into these internet companies regardless of their profitability, fueled by FOMO. This influx of money created an even worse loop, pushing stock prices even further. When that was not enough, investors started to look for chain effects and pushed even companies with limited track records to the skies.
However, this frenzy could not be sustained forever. Eventually, investors wanted to cash out. This triggered a wave of selling pressure, and investors who bought into this dream based on FOMO and rumors were now holding the bag. As the prices declined rapidly, even more investors wanted to protect their assets and sold, even increasing the pace of the downward spiral cycle. In early 2000, the market could not withstand the pressure and crashed, the tech-heavy NASDAQ stock exchange plummeted over 78%, wiping out trillions of market value, leaving investors with significant losses.
This sent a ripple effect through the economy, with businesses shutting down and job losses. For many, it was a personal economic disaster. Eventually, this led to regulations such as increased scrutiny by the SEC, the Sarbanes-Oxley Act, and a heavy focus on company fundamentals, as mentioned in my previous blog post.
A quick mention, however: some companies that had a sustainable business model came out ahead, like eBay and Amazon.
Real World example of FOMO in the making?
Let’s take Pinterest, Inc. for example, with its P/E ratio of 194 and a minuscule EPS of $0.22. Let’s bring forth our calculator and do some quick math like Big Shaq (Man’s not hot)…using some broad assumptions.
- P/E Ratio (Price-to-Earnings Ratio): This ratio indicates how much investors are willing to pay for each dollar of a company’s earnings. In your example, the P/E ratio is 194.
- EPS (Earnings Per Share): This represents the company’s profit per outstanding share of stock. In your example, the EPS is $0.22.
Plugging in the numbers:
- Years to Catch Up = 194 / 0.22 ≈ 872.73 years
I’ll leave this mental gymnastics to someone more mentally unchallenged, an expert in economics perhaps. Because clearly, my pea brain is too unsophisticated to comprehend how a company can be reasonably valued at nearly a millennium’s worth of earnings at their current run rate.
What are your thoughts on Pinterest’s sky-high P/E ratio? Is it a case of FOMO or justified by future potential? Let me know in the comments!
coming up..
Part 3: Strategies to Avoid FOMO and Emotional Investing
I’m going out on a disclaimer
This is for entrainment purposes only, always do your own research before investing
References:
Ofek, Eli and Richardson, Matthew P., Dotcom Mania: The Rise and Fall of Internet Stock Prices (December 2001). NBER Working Paper No. w8630, Available at SSRN: https://ssrn.com/abstract=293243
