In January 2000, a sock puppet starred in a Super Bowl advertisement. It was the mascot of Pets.com, an online shop that delivered pet food, and the ad slot cost more than a company its size could sensibly spend. That did not seem to matter, because a month later Pets.com held its IPO, an initial public offering, the moment a company first sells its shares to the public. Investors handed tens of millions of dollars to a business that lost money on almost every bag of dog food it shipped. Nine months later it was gone. Not restructured, not rescued: shut down, that same November, the sock puppet sold off with the office furniture.
That nine-month arc, from Super Bowl ad to liquidation, is the dot-com bubble in miniature. But the reason this mania deserves its own entry is not the sock puppet. It is that the people who inflated this bubble were, in the most important way, correct. The internet really did change everything. And they lost fortunes anyway. Hold both of those facts at once and you are holding the most useful lesson in this whole series.
What people believed
By the mid-1990s the internet had gone from a research curiosity to something your neighbor used. The belief that formed around it had two layers. The first layer was true: this technology will change how everything is bought, sold, read, and watched. The second layer was smuggled in underneath the first: therefore any company attached to it deserves any price.
The old way of judging a business, profits, cash, assets, was declared obsolete. Profits were "old economy" thinking. The new economy had new metrics: eyeballs, meaning how many people visited your website, and clicks, meaning how often they pressed a button once there. Companies were valued on the attention they attracted, not the money they made, on the theory that the money would arrive later, after the land grab. Some companies simply added ".com" to their name and watched their share price jump on the announcement, which tells you what the market was actually pricing: the syllable, not the business.
Edward Chancellor, whose history of manias, Devil Take the Hindmost, is the backbone of this series, observes that every bubble tells a new-era story. A tulip bulb never had a story worth believing. Railways did, and radio did in 1929, and the internet had the best story of all. That is what made it dangerous. The better the story, the more completely it answers the question the price should be asking.
How it inflated
The machinery was the machinery of every mania before it, upgraded with television.
Companies with no profits, sometimes with barely any revenue, went public, and some of those shares more than doubled on their first day of trading. A first-day double sounds like triumph. Read it again: it means buyers were paying twice the morning's price by evening, for the same unprofitable company, purely because it was for sale.
The analysts, the people banks employ to judge publicly whether shares are worth buying, worked for the same banks that were collecting fees for taking those companies public. They rated almost everything a buy. Years later, regulators fined the big Wall Street banks over precisely this conflict of interest, but by then the money was gone. If you read the myth of the financial expert, you already own the rule that would have protected you: before you take advice, ask how the adviser gets paid.
Around the professionals, ordinary life bent toward the market. People quit stable jobs to day-trade, buying and selling shares within hours, for a living. Television channels covered share prices the way they covered sports. And Pets.com bought a Super Bowl ad, because in a mania, being seen feels like the same thing as being sound.
How it burst
There was no black day. That is the strangest part, and the most instructive.
The Nasdaq, the American exchange where most technology shares traded, peaked in March 2000. Then it stopped, wobbled, and began to slide. Rallies kept arriving, and each one was greeted as the bottom, and each one failed. The slide ran for roughly two and a half years, and by late 2002 the Nasdaq had lost roughly four fifths of its value from the peak. Hundreds of dot-coms did not fall in a crash; they simply ran out of money, quietly, one by one.
Compare 1929, which had named days of panic. The dot-com bust was a grind, and the grind carries its own lesson: exits are not announced. Anyone waiting for an unmistakable signal to leave got two and a half years of ambiguous ones, each small enough to explain away. If your plan for a bubble is "I'll get out when it turns," understand that the turn looks, for months at a time, exactly like a buying opportunity.
The arithmetic of four fifths
Losses are not symmetric with gains, and a crash this deep makes the asymmetry brutal. The percentage you lose and the percentage you need back are different numbers, because the gain has to be earned on the smaller amount.
| The fall | The gain needed to get back to even |
|---|---|
| 20% | 25% |
| 50% | 100% |
| 80% | 400% |
| 90% | 900% |
Now the worked example. Say you had €10,000 in a basket of technology shares at the March 2000 peak. A fall of four fifths leaves €2,000. To get back to €10,000, that €2,000 must multiply by five: a 400% gain. Assume it then grows at 7% a year, roughly the long-run average of a broad stock index, an illustration, not a promise: the climb back takes about 24 years. The real Nasdaq, helped by an eventual boom, still needed about fifteen years to see its March 2000 level again. A deep enough hole converts even a good decade into a rescue mission.
The believers were right
Here is the twist that makes this entry different from tulips, the South Sea, and 1929, and it is the whole reason this series exists.
The believers were right. The internet did change everything: how you shop, read, work, listen, argue, and, eventually, how you do everything this blog teaches. The optimists of 1999 won the argument about the technology, completely and permanently.
Amazon is the cleanest proof. Through the crash its shares fell roughly 90% from their peak. The company survived, kept building, and went on to become one of the most valuable businesses on earth. Both facts belong to the same shares. And check the table above: a 90% fall needs a 900% gain, a tenfold rise, just to get back to even. The investor who bought Amazon at the peak was right about the internet, right about the company, and still spent years deep underwater. Most holders of most dot-coms never got the recovery at all, because most of the companies died.
Being right about the technology and wrong about the price are fully compatible, and the price is the part you live with.
This is the purest bridge from financial history to value investing. A world-changing idea tells you nothing, nothing at all, about whether the shares are cheap, because price and worth are two different quantities and a mania is what happens when an entire market forgets that. In the index funds article we called owning a single company naming your bet. The year 2000 supplies the missing half: every bet has two parts, what you think will happen and what you paid for the ticket. The dot-com crowd got the first part right and the second part catastrophically wrong, and the second part decided everything.
The most expensive sentence in finance
"This time is different." The warning is proverbial by now; the investor John Templeton is widely credited with calling "this time it's different" the four most dangerous words in investing. Every mania in this series ran on some version of that sentence. Tulips were a new kind of flower, the South Sea Company a new kind of state finance, 1929 a new era of industry, and 1999 a new economy.
The dot-com bubble is the version that should haunt you, because in 2000 the sentence was, for once, true. The time genuinely was different. The technology genuinely was new. And the losses were exactly the same as always, because prices are never exempt. World-changing technology bought at world-changing prices produces ordinary losses. If the sentence could not save the people who were right, it will not save the people who are merely confident.
Do this now
Take ten minutes and a piece of paper. Write down the technology you are most certain about today, the one that so obviously changes everything that doubting it feels silly. Then write two questions underneath. First: what do I believe about this technology? Second: what does the current price of the famous companies attached to it already assume? If you can answer the first fluently and the second not at all, notice that this was the exact position of most investors in March 2000. Keep the paper. Read it again in five years.
Next in the series: Manias V: 2008, the mania that came for houses, and the finale that every article in this blog was quietly preparing you for.