Even with the pandemic and the sharp drop in the market earlier this year, we’ve seen tech stocks rally to new highs, especially for some of the tech giants in the world.
Most notably, we’ve seen companies like Amazon (AMZN), Zoom (ZM), and Tesla (TSLA) reach record highs even when so many other industries are suffering from the virus’s impact.
Traveling back in time to the 2000s, we saw a similar timeline when the Nasdaq surged past 3000 to the 5000s in a matter of months before tumbling down in April 2000, which signified the dotcom bust.
To really investigate if we are in a tech bubble, we need to take a look into the past and see what occurred back in the 2000s.
The 2000 tech bubble
If you are unfamiliar with the whole situation, in short, much of the tech bubble was caused by speculation around the use and adoption of the ‘internet’ and such, the formation of new tech companies that circled it.
We’ve all heard the stories of ‘internet entrepreneurs’ making their fortune (like Mark Cubans) from this era and the subsequent crash that followed.
Many that got away were ones that managed to sell their business before the crash, while others managed to ride out the wave by forging partnerships with competitors like X.com and Paypal.
It was an era of speculation
One of the biggest reasons there was a tech bubble in the first place was the hype around technology and the shift towards the “Information Age.” Ownership of computers rose from 15% to 35% from the early to late 1990s, and everyone wanted to get in on the tech ride.
Additionally, with a variety of policies in place (including the Taxpayer Relief act of 1997), capital was available at lower interest rates, which meant a huge influx of money in the market.
This meant that many investors were eager to splash money into anything that had a ‘.com.’ prefix or any internet company due to the high growth that came with it.
This subsequently led to insane valuations of technology companies and subsequent focus on growth rather than clean finances.
These companies were also spending money left and right on anything they could get their hands on from billboards to Superbowl ads.
The numbers, however, didn’t match up
In a 2000 article published by Bloomberg, it was clear that there were some questionable revenue reports with ‘aggressive’ accounting practices (a reminder of WeWork). Many tech companies were inflating their revenue with some like MicroStrategy stating revenues way too soon.
“Investors haven’t been caring about the quality of revenues — just whether revenues are going up,” says Jack Ciesielski, editor of the Analyst’s Accounting Observer, a Baltimore-based newsletter. Now, “tech companies are going to have a little more trouble pulling off some of the hokier forms of revenue recognition.” MicroStrategy says it thought its original accounting was reasonable.
As time went by, it was clear a lot of these tech companies were all on this, and valuations were exceedingly above what the realistic values of these companies were.
It was also clear many of these companies were running out of cash, and as more negative news piled up, eventually, it all came tumbling down.
By the end of the downturn in 2002, stocks had lost 5 trillion dollars since its peak.
Ok so what about now?
If you’re familiar with startups and the current market conditions of tech companies, this might already sound similar; these are big tech giants and startups with huge valuations that sometimes don’t make sense.
What is more alarming are startups that have these assessments with barely any revenue in the door and instead a ‘speculative’ valuation on the company’s worth.
Most of the time, this comes down to future speculation as well as what investors think the technology is worth years down the line, especially in areas of deep tech like AI.
Although this may sound like a repeat of the 2000s, there is a big difference compared to what happened in the past.
Technology has a footprint in every industry
One of the clear differences is that technology has now evolved to a point where it exists in every industry in different forms.
It could be as simple as an email software to a sophisticated AI tool.
There is no doubt that technology has shaped how we work and has especially helped the world continue moving even during uncertain times.
Imagine if the pandemic happened, and we didn’t have the ability to remote work or video conference. This paints a picture of how much technology has influenced us, especially in a time of need.
Growth of tech companies vs. “Offline” companies
There is also no doubt that tech companies have tremendous growth margins of revenue vs. traditional companies.
Let’s take a look at some of these differences through some graph below:
In the graph above, we see that the listed tech companies have grown by 40–80% on average.
Compared to the average growth rates of the more traditional offline companies below, we see most of them are below the 10% rate. Hence we see why there is a massive adoption and focus on investing in tech stocks rather than slower “offline” stocks.
So we are in a bubble and is it about to pop?
Ok, so we’ve made a point that technology now is much different from the 2000s and the fact that technology has ‘proved itself’ compared to back then.
Looking closer at the definition of what a bubble is, it does point towards the fact that we are in a tech bubble.
“I define a bubble as something where assets have prices that cannot be justified with any reasonable assumption,” says Jay Ritter, a professor of finance at the University of Florida’s Warrington College of Business Administration who studies valuation and IPOs
As discussed above, there are plenty of tech companies where the justification of the prices of their “assets” may be questionable.
However, to compare 2000 and now would be unfair.
In my opinion, even if a tech crash does occur soon, it would not be at the levels of the dot combust.
Instead, what we might see is a correction of the valuation of many smaller tech companies as well as many private startups that have not yet IPOed.
A clear example of why this might occur is WeWork.
As soon as WeWork had to display all its finances to IPO, there was a discovery of questionable accounting practices that subsequently lowered its valuation substantially. There are also plenty of other startups that have had their valuations decreased due to similar reasons.
In my opinion, it will be a period of ‘cleaning up’ rather than a full-blown crash, but only time will tell as we approach the future.