A comparison between the dot-com bubble and the 2021 tech bubble shows that companies were far more overvalued in 2000 than in 2021.
During the late 1990s, there was large-scale adoption of Internet technology which created massive growth across the venture capital space.
The growth was fuelled by tremendous hype and a low-interest rate environment, making money cheap.
The combination was lethal and caused share valuations to reach unprecedented levels. From the beginning of 1995 to its peak in 2000, the S&P 500 grew by 226%.
The massive hype around Internet stocks created large capital flows toward start-up companies that, in many cases, did not even have business plans.
Eventually, the capital dried up as many of these start-up companies failed to become profitable. The market crashed, wiping out most of the growth.
Fast forward 20 years and a similar scenario occurred in the technology market with low interest rates and great hype around tech stocks.
At the low cost of borrowing, many tech companies could access cheap capital and ramp up their operations at high leverage, creating strong profit margins.
During 2021, stock markets boomed on the back of strong growth in tech stock valuations.
However, as central banks started ramping up interest rates to combat inflation, growth rates and profit margins took a turn.
Many large tech companies reported a slowdown in growth and profitability, which scared investors. The market collapsed, and many company valuations were adjusted.
Dot-com bubble versus tech bubble
Daily Investor compared the price-to-earnings (P/E) ratio of the S&P 500 during the dot-com bubble and the recent tech bubble in 2021 to spot similarities.
We tracked the P/E ratio from 1995 to 2003 and compared it to the P/E ratio from 2014 to 2022.
Interestingly, the S&P 500 reached a much higher P/E ratio during the dot-com bubble than during the 2021 tech bubble.
During 2021, the S&P 500 had a peak P/E ratio of 39 times earnings. It was significantly lower than the dot-com bubble, which peaked at 47 times earnings.
To put this in perspective, the S&P 500 traded at an average P/E ratio of 24 over the last thirty years.