Web 2.0 - Are We Headed for Another Dot-Com Bubble & Burst?

You probably remember the dot-com bubble in the late 1990's. I was busy having acne and trading baseball cards at the time, but even I remember it happening. The crux of the issue: stocks of tech companies were inflated beyond their real values and when everyone figured this out, they sold their shares of the overvalued companies. Prices dropped quickly (supply and demand, folks) and a lot of people lost a lot of money.

Why were these companies overvalued in the first place? Media reporting had a lot to do with it and irrational actions by way too many investors drove the bubble to bust. There were also A LOT of questionable accounting practices going on behind the scenes, which made some stocks seem like a more reasonable investment. Crowd behavior was the big thing, though - people stopped looking at traditional investing tools like "Price to Earnings Ratios" and started qualifying stocks based on the product they promised to deliver. I'm sorry, but that is madness. The media didn't help, putting commentators that backed these companies front and center - after all, the dot-coms were paying for advertising space on their networks with all this new cash. Gotta love capitalism!

So, are we headed for the same future with Facebook, Twitter, Google, and MySpace? I don't think so. And here's why:

1. It's too soon. As George Bush once said, "There's an old saying in Tennessee — I know it's in Texas, probably in Tennessee — that says, fool me once, shame on — shame on you. Fool me — you can't get fooled again." Eloquent, he is not, but he makes a relevant point: most investors are still feeling the pangs of loss from the first dot-com bubble to get roped in again.


2. The American recession is stopping it. In the first dot-com boom, venture capital was pretty easy to come by if you wanted to start a company with either an e- prefix or a .com suffix. These days, start-up money is tougher to come by and, as a result, fewer worthless ideas are being funded. Companies are also innovating faster both internally and laterally as a result of competition for both IP and the almighty dollar, which is closing a lot of gaps that new companies would be looking to fill. So, uh, again, Bush is behind this one. Sorry.

3. The "bubble" is small enough to sustain itself - for now. Web 2.0 companies fall into two categories - monsters of industry (Google, eBay, Yahoo!, etc) and companies that get acquired by monsters of industry. Since there are fewer "check out this hot stock tip" companies floating around, market speculation as a whole is lower, so there isn't enough unjustified investment for the whole deck of cards to collapse - for now.

4. These companies have real money. The dot-coms had mostly speculative value from their IPOs and no real income to justify their accounting statements. Most of the companies in question (notably Google) have cash reserves and income streams to back up their real buying power. This is a stark contrast to the IPO-based valuations of dot-com companies, which as we saw were largely erroneous. Erroneous! Erroneous on all counts! You take that back, Dorothy Mantooth is a saint!


Not that I'm endorsing a blind investment in these, or any other, companies. Always do your homework when it comes to investing, kids!

Extra Credit Reading (also: these are where I got a lot of the facts for this article, I try not to plagiarize.)
Random Walk Down Wall Street - timeless book
Extraordinary Popular Delusions and the Madness of Crowds
BBC's Take on Bubble2.0