Many of us started investment during the technology dot.com era which resulted in many losing a lot of money. Due to this bad experience, many people turned away from investment permanently. Others picked up the pieces and move on repeating the same mistakes again. To make mistakes is not unusual but not learning from the mistakes is the worst kind of mistake. In this article, we will go back in history and examine the lessons we can learn from the dot.com bubble so that we can make better decisions in our investment plan.

Why the craze over technology companies?

Figure 1 shows the index chart from 1984 to 2005 of the NASDAQ Composite Index. From the chart, there is no obvious point in time which the dot.com started its bull run. For more then one decade prior to year 2000, the NASDAQ has been on a steady ascend. However on 20 July 98, the NASDAQ had a violent correction of -31.98% (in SGD) over just 2 ½ months. It does seem that this correction represents the launching pad for the dot.com madness. Just 2 ½ months after 20 July 1998, the NASDAQ index begins its Mount Everest ascent starting 8 Oct 1998 (marked by number 1 in the chart). The index rose by 269% (SGD) over just 15 months reaching its all time high on 10 March 2000 (marked as 2). Subsequently the bubble burst and the index rapidly declined by -77% (SGD) until 9 Oct 2002 (marked as 3). The decline could have ended earlier if it was not for 911 terrorist attack on United States, which was followed by Afghanistan war.

Figure 1: NASDAQ Composite Index from 1984 to 2005

The madness during the dot.com era was the belief that small startup companies were able to leverage on the Internet in delivering services across the globe using what was known as network effect. Suddenly the world became the marketplace so to speak. Many startup offers portal services over the Internet and some even offered free services in hope of drawing large traffic volume so that advertisements through the portals would eventually provide for the profitability of these companies. Typically such companies raised huge capital through Venture Capitalist funding and/or through the issue of shares in the stock exchanges. However, these companies’ debts actually rose rapidly, as it was belief that expansion is more important then profitability. As a result, many of such companies were operating in huge loses. In reality there was no sound business model and neither was there any real products other then nice stories. At the same time, speculators who believed in these stories begin to pure huge amount of money in technology companies. As seen from the chart, the price index rocketed sky high. Founders of these dot.com companies suddenly became millionaires on paper. Employees who were given stock options became paper millionaires too. As we know today, the bubble finally burst. The reasons for the burst were simply because:

1. Dot.com companies had no sound business plan
2. These companies were not profitable
3. Valuations were ridiculously high

In other words, there was nothing fundamentally good about these companies. In fact, any investment that seems to be attractive but is not supported by sound fundamentals is guaranteed to be money losing. There were a few dot.com survivors such as Yahoo and Amazon but these surviving companies were the minority. Majorities finally call it a day.