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Dot Com Bubbl

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Dot-Com Bubble

Table of Contents
Abstract ................................................................................................................................................... 3 Introduction ............................................................................................................................................. 4 Causes ..................................................................................................................................................... 4 Effects ..................................................................................................................................................... 5 Lessons learnt.......................................................................................................................................... 7 Conclusion .............................................................................................................................................. 7 Appendix ................................................................................................................................................. 8 Reference List ......................................................................................................................................... 9

Abstract
This report presents an analysis of a stock market bubble, well known as “dot-com bubble”, which developed roughly during a period from 1995 to 2000, and ended up in 2001. The report discusses core reasons behind the bubble, the overall impact of dot-com bubble and summarizes various lessons learnt from this crisis. This was a speculative bubble, based primarily on expectation of rapid and high volume growth from the newly arrived internet related tech-companies. The term dot-com is termed after the domain name “.com” which is used by most of the newly formed internet related companies in their web addresses. Bubble collapsed in 2001 forcing stock markets in a series of serious corrections which wiped off a large portion of market capitalization, ending up many newly formed companies, and disclosed various accounting frauds. The crisis endorsed need for adequate investment evaluation through core financial and business evaluation tools, instead of simply speculating over the growth potential solely based on expectations which could not be supported by actual numbers.

Introduction
“Dot-Com Bubble”, as the name indicates, refers to a speculative bubble which appeared in the stock markets roughly during 1995 to 2000. The artificial bubble was mainly based on an expectation of fast paced growth from newly arrived internet related companies. However, by March 2000, which was the peak, bubble started to deflate after it was realized that IT companies’ were actually losing and covering them through accounting frauds coupled with a lack of cash flow required to continue. The crisis continued till October 2002, which wiped off many newly formed companies and made investors to lose roughly five trillion of market capitalization.

Causes
By 1995, growth in number of internet users introduced investors to a new face of economy, suggesting them to put in their wealth in this untapped market of internet users having access to a large global base. During the period of bubble formation, investors primarily get attracted to a company’s involvement in an e-commerce or internet related activity, which served as the prime reason for investment, while ignoring the fundamental and technical metrics for investment evaluation. The basic idea was to offer an internet related service or product, achieve a huge user base, and expect large sums of profits in future due to the large base of internet users. As the excitement grew, it resulted in formation of many new companies that were backed by an internet based idea. This large supply of newly formed internet and tech-related companies proved to be attractive for excited and speculative investors, who were ready to accept them, without feeling a need to scrutinize their core business metrics (as cash flows, revenue source, profit generation etc.). Many newly formed companies even brought in some

daring business ideas which were unusual and new to the market, on the hope of profits generated solely on the base of large no. of internet users. Venture capitalists usually backed these new start-ups, brought them on a public platform and earned large profits in a very short period of time due to speculative nature of the market. The stock market was so excited that stocks of these newly arrived tech companies were easily expected to increase, many even doubled the very first day. NASDAQ Composite index, which was considered to be a home for a large number of technology companies, reached a record high of 5,048.62 in its intra-day trading on March 10, 2000 (Goldman & Pett, 2013). Unfortunately, it was later identified that the hype, volume, growth and profitability expected from these tech-related companies was an illusion. Various cases came to the front shaking trust of many investors. It was identified that most of these companies have used up almost all of their available cash and need to raise further cash in order to survive as a going concern. Increased interest rates during 1999 to 2000 (World Bank data, 2014) also made it difficult for these cash thirsty companies to raise further money. Later on, investors also got surprised by losses and accounting frauds reported in these internet and tech-related companies which further heated the overall atmosphere. Some outside factors as 9/11 terrorist attack and heavy outsourcing leading towards unemployment also added fuel to the fire.

Effects
Annual and quarterly results, along with various fraud cases, emerged in March 2000, which unveiled the true picture prevalent in the market. As a result, high volume selling pressure emerged and markets started to decline after reaching a record high level of 5,048.62 (March

10, 2000). Only by March 20, 2000, NASDAQ shed more than 10% of its peak value, which was considered to be the most tech-saturated index. A series of correction started from March 2000 and continued till October 2002, which forced investors to lose roughly five trillion US Dollars worth of market capitalization (Gaither & Chmielewski, 2006). NASDAQ Composite index crashed from 5,048.62 in March 10, 2000 to a level of 1,114.11 (Goldman & Pett, 2013) by October 9, 2002 translating into a loss of 78% in NASDAQ (Appendix A and B). Bubble’s deflationary effect forced many tech-companies to file for bankruptcy. They faced a severe lack of capital, coupled with a six times increase in interest rate by Federal Government which made borrowing more costly especially for companies who already held large debts. They were left with no other alternative, except being liquidated or acquired. Several newly formed internet companies closed without ever making profit (Goldman 2010). Later, various fraudulent accounting practices were also identified which further lost trust of investors, enhancing the already prevalent selling pressure in the stock markets. A notable case during this period was of WorldCom. WorldCom was engaged in exaggerating its profits by fraudulent accounting practices, and after being identified of such an act, WorldCom filed for bankruptcy which is considered to be the largest corporate fraud in U.S. corporate history (Howe, 2011). This overall impact also forced the economy towards a mild recessionary period leading towards unemployment for IT related professionals, and later 9/11 terrorist attack further fueled the stock market crash.

Lessons learnt
“Dot-Com Bubble” crisis forced investors to lose trillions of dollars, teaching them some serious lessons. The crisis endorsed traditional need for a detailed and adequate investment evaluation through core financial and business tools, instead of simply speculating over the growth potential based purely on expectations, which could not be supported by actual numbers. Long term investment could not be based solely on the criteria of “picking currently hot stock”, which is currently performing well solely due to speculation of an attractive opportunity and ignores key evaluation metrics. Companies not only need to have a good business idea and a large potential market, as in the case of many newly formed internet focused companies, but they should be well equipped with a strong business model which allows them to properly sustain, operate and fetch maximum potential from their market achieving desired results. Sound financial and business model along with identification of reliable revenue generating avenues is the key for success and continuity, which was primarily ignored in the investment decisions made during the “Dot-com Bubble” period.

Conclusion
“Dot-Com Bubble” crisis forced investors to lose trillions of dollars, teaching them a tough lesson that speculative investment may work only in a short term period and only for certain investors. However, this approach would not continue for much long, as the initial investment decision ignored a proper and detailed evaluation of business model which acts as a screening process. As a result, the speculation would restrict the market from a sustainable long term growth and would end up in a crisis, as it did in “Dot-Com Bubble” crisis.

Appendix
A

B
NASDAQ Composite Index - March 10, 2000 NASDAQ Composite Index - October 09, 2002 Fall in terms of percentage 5,048 1,114 78%

NASDAQ
6,000

5,048 5,000
4,000

3,000
2,000

NASDAQ 1,114

1,000
-

NASDAQ Composite Index March 10, 2000

NASDAQ Composite Index October 09, 2002

Reference List

Goldman, M. Corey & Pett, David, 2013, ‘Nasdaq hits 4,000: Same number different world’, Financial Post, November 26, Viewed 01 April 2014, [ONLINE]. Available at: http://business.financialpost.com/2013/11/26/nasdaq-4000-same-number-different-world/.

World Bank data, 2014, ‘Real interest rate (%) Data Table’, Viewed 01 April 2014, [ONLINE] Available at: http://data.worldbank.org/indicator/FR.INR.RINR?page=2.

Gaither, Chris and Chmielewski, Dawn C., 2006, ‘Fears of Dot-Com Crash, Version 2.0’, Los Angeles Times, July 16, Viewed 01 April 2014, [ONLINE] Available at: http://articles.latimes.com/2006/jul/16/business/fi-overheat16.

Goldman, David, 2010, ’10 big dot.com flops’, CNN Money, March 10, Viewed 01 April 2014, [ONLINE] Available at: http://money.cnn.com/galleries/2010/technology/1003/gallery.dot_com_busts/

Howe, Alex, 2011, ‘The 11 Largest Bankruptcies In American History’, Business Insider, November 29, Viewed 01 April 2014, [ONLINE] Available at: http://www.businessinsider.com/largest-bankruptciesin-american-history-2011-11?op=1.

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