By: Shaan Bharwani
The public introduction of the internet, more specifically the World Wide Web, on August 6, 1991 marked the beginning of the world we live in today. With its launch, business expanded into a format never seen before. This brought us Instagram, Netflix and every online retailer you have ever bought from. Predating these innovations, the hype of the internet led to the dot-com bubble and its subsequent crash in 2000. A similar stock bubble is suspected to have formed within our current technological industry, which has led to investors asking when the inevitable burst will occur.
What is a bubble?
A stock bubble is a period of economic growth within the stock market (usually focused on some sort of specific industry) where the stock price of the industry escalates past its intrinsic value by an outstanding margin. The bubble forms when companies under the industry are trading on the market for prices significantly higher than their asset value; in other words, the companies have very high P/E ratios. Measured by dividing the market stock price by the total earnings of the company, the P/E ratio of companies in a bubble is usually significantly higher than 50 in comparison to the average 28.5 ratio of S&P 500 companies. The primary example of this is the aforementioned Dot-com bubble. During it, the NASDAQ was trading at a “P/E ratio of 187.9” with Cisco, Intel and Oracle leading the charge (Reuters, 2015). This exorbitant trading rate was apparent with Dot-com stocks (ending in .com or starting with www) trading at ratios of 200 or higher. This bubble “burst” in 2000 when stocks became strained with the P/E ratios and the market investors lost a total of $5 Trillion.
How does Dot-com compare to Tech?
There is no ignoring the massive upturn tech stocks had in comparison to the general downtrend of the stock market during March and April of 2020. Following a federal stimulus, the market as a whole stabilized, yet tech stocks continued to race ahead of the market. This expansion has led many investors to conclude that a new bubble has formed, so now the question is whether or not it will be as large and as devastating as the Dot-com bubble. According to a Goldman Sachs analyst, “the S&P 500 index concentration in the top tech companies — Facebook, Amazon, Apple, Microsoft, and Alphabet — was the greatest it has been in 20 years. That was a level not seen since 2000” (Markets Insider, 2020). As stated earlier, Dot-com stocks were trading at P/E ratios of up to 200 during their bubble in the late 90s and the very beginning of the 21st century. In comparison, two of the largest tech stocks right now, Amazon and Facebook, are trading at P/E ratios of 100 and 35 respectively. Immediately, there is a large discrepancy between these two bubbles. This has led investors to believe that there is a much lower chance of the bubble bursting. Investors have learned from the failure of Dot-com which was caused by trigger-happy mentalities that any stock under the category, regardless of equity, would reach the moon. This has, thankfully, led to many discrepancies between today’s tech bubble versus the 2000 Dot-com.
Verdict
No, big tech is not a second Dot-com bubble. The industry is just a powerhouse of companies that investors are very hopeful about. As everyone knows by now, technology is the future, which is reflected in the overwhelming success of the industry. This may actually be the defining factor that differentiates the current bubble from the former. Today’s companies have a very solid financial footing and level of maturity that was definitely not reflected in the “superstocks” during the 90s. Many of the most inflated stocks (high P/E ratios), such as Amazon and Microsoft, have strong financial backing and a stable foundation that can take a hit in the case of a bubble burst. Whether or not the tech stocks will burst soon is still up for speculation, but the results of this sort of burst will have nowhere near the catastrophic market effect that the Dot-com bubble had.
Market bubbles are an inescapable trend with no set schedule of when they appear. It is the job of economists and the personal responsibility of financially literate investors to discover them before they get too dangerous. Following the Dot-com crash, market analysts have constantly been wary of newer bubbles which is why the current one was caught so quickly as it developed during this present Covid-19 pandemic. Due to this insight, this bubble will not have the ability nor the stealth to be as devastating as the Dot-com.