Ten years ago, investors knew that technology would change the world, and they were right. But you can be 100% right about the future and end up with zero to show for it if you overpay in the first place.
On March 10, 2000, the Nasdaq Composite index closed at a record of 5048.62, up 24% since the beginning of the year, after an 86% gain in 1999. And many were calling for the Nasdaq to hit 6000 within a year or two.
It closed Tuesday at 2340.68.
What went wrong? Looking back with 20-20 hindsight, you might think that millions of investors had gone insane. Americans in every walk of life—barbers, taxi drivers, waiters, air-traffic controllers—were convinced that they could get rich quick by trading Internet stocks.
Technology shares were going up more in a few weeks than traditional stocks normally gain in a decade: PMC-Sierra Inc. had tripled since the end of 1999, while Juniper Networks Inc. and Inktomi Corp. had more than doubled. Yahoo Inc.’s stock traded at about 2,000 times the company’s earnings per share. Amazon.com—which, like 15% of the companies on Nasdaq, had no earnings—traded at roughly 48 times its book value.
It’s tempting, but wrong, to write off the tech mania as mass insanity by the ignorant and ill-informed. In March 2000, a survey of chief financial officers by Duke University found that 82% of these sophisticated insiders felt that their stock was underpriced, 15% thought it correctly priced and only 3% overpriced.
Most of the consensus favorites among tech stocks turned out to be investing disasters. But in an odd way, the Internet bubble has left all of us better off, as its benefits have percolated throughout the economy and produced huge productivity gains across all sectors. The same cannot be said for all bubbles; many homeowners aren’t better off just because the real-estate frenzy put millions of people into homes they couldn’t afford.
Technology was transforming business so fast that “nobody knew how to value things,” says Elroy Dimson, a finance professor at London Business School and co-author of the definitive history of global stock returns, “Triumph of the Optimists.” Adds Prof. Dimson: “There were lots of people who thought those were crazy times, but the consensus view was that cash flows would keep growing rapidly.”
Like most bubbles, the tech mania was rational and foolish at the same time. Investors foresaw a market opportunity that would be explosively profitable. Then, having no sure way to know who the ultimate winners would be, they bid up every company having anything to do with that opportunity.
The Internet did change business forever, just as investors had predicted. And a handful of technology companies did strike it rich. But by far the biggest beneficiaries of the Internet boom were the companies that adopted the new technology rather than those that provided it. When I asked Aronson+Johnson+Ortiz LP, a Philadelphia money manager, for a list of the 100 top-performing stocks over the past decade, the roster was dominated by energy, health-care, materials, industrial and even financial companies. Only eight tech stocks made the list.
That’s mainly because their share prices got so inflated in the first place. As businesses, tech companies did very well. Technology was the most profitable sector in the Standard & Poor’s 500-stock index in 2009, contributing $93 billion of earnings, estimates Strategas Research Partners. Since the beginning of 2000, tech companies have generated $608 billion in cumulative profits. They have piled up $349 billion in cash, or 35% of the total at nonfinancial corporations. And over the past 10 years, Amazon has doubled even as the S&P 500 went nowhere.
But back in March 2000, the 10 largest tech stocks were valued at a total of $2.4 trillion, or 19% of the S&P 500’s market capitalization. Since everyone was sure that the Internet was a winning technology, but no one could know exactly who the winners would be, investors paid through the nose for just about every Internet-related stock. Among those 10 biggest tech stocks: Lucent Technologies, Nortel Networks Corp., America Online and Sun Microsystems Inc., which all went on to lose most of their value.
It’s a Wall Street cliche that “investors hate uncertainty.” The clearest lesson of March 10, 2000, is that uncertainty is the only thing investors should like.