Are we in a tech bubble?
This question is on many investors’ minds today.
Now, it’s hard to say for sure – and some individual tech stocks may continue to perform well in the future.
But the tech rally might have veered into the territory of irrational exuberance.
Look no further than Nvidia.
The chip technology company recently became a trillion-dollar enterprise and the world’s newest tech giant.
Right now, Nvidia is trading at a mind-boggling 24 times its next 12 month’s revenue. That’s not even earnings, just revenue.
And it’s not just Nvidia.
The AI narrative is driving tech returns across the board.
The S&P 500 Information Tech sector has already climbed 41% this year. Compare that to the broad S&P 500’s 17% gain.
But here’s the thing about narratives… They can be very risky in investing.
They may lead you to follow the crowd’s sentiments instead of taking a hard look at the fundamentals.
And that’s what I believe might be happening with tech stocks right now.
We’ve Been Here Before
The situation with tech stocks and AI right now reminds me of the dot-com bubble of the early 2000s. I was working on Wall Street at the time.
When the dot-com bubble burst, it was a watershed moment for hundreds of tech companies. And those that survived were nearly wiped out.
Case in point: Amazon.
On December 16, 1998, an analyst named Henry Blodget from Oppenheimer made a move that caught people’s attention.
He raised the price target for Amazon (AMZN) stock to $400.
At the time, Amazon traded for about $243 a share. But Blodget believed Amazon was in the early phases of becoming a significant global e-commerce player.
It had the potential to reach $10 billion in revenue, he thought, and earnings of $10 per share within five years.
On that same December day, Amazon’s stock surged 19%. It hit $289 in what became the pinnacle of dot-com fever. Amazon snagged the second spot among the top risers in the market that day.
Other online retail stocks also got a boost. Books-A-Million, another online bookstore, spiked 80% in just one day. eBay jumped 11%, and Barnes & Noble went up by 7%.
Even back then, these valuations appeared too good to be true. And yet, people couldn’t resist diving headfirst into the hype and excitement of the bubble.
This was happening even as Amazon continued to report losses every quarter.
Several analysts said Blodget’s valuation was based on hype. But he argued that, as with most internet stocks, valuing Amazon was more of an art than a science.
Three weeks later, it seemed that Blodget was proven right.
On January 6, 1999, the stock hit $400, like Blodget had predicted. After that, it didn’t take long for it to go to $600.
Blodget’s analyst reputation soared to legendary status. He joined Merrill Lynch, reportedly with a substantial salary increase. And he became a prominent advocate for dot-com stocks on CNBC.
But a year later, in 2000, the dot-com bubble burst.
And Amazon? See for yourself. Here’s a chart of Amazon’s share price (adjusted for the numerous share splits it has undergone since then)…
The stock declined 94% between 1999 and 2001. It’s safe to say many Amazon shareholders who followed the hype in ’99 got wiped out.
After a 94% plunge, you’d need roughly a 1,567% gain just to get back to breakeven.
For Amazon investors who were able to hold on for the long run, it might have worked out when Amazon became a success story.
But the majority of tech plays from the dot-com bubble era failed to come anywhere near replicating Amazon’s long-term success.
What This Means for Your Money Today
Here’s the bottom line…
These investors overestimated hyped-up companies burdened with inflated valuations. And they got the timing wrong.
But they weren’t wrong about the future during the dot-com bubble. Plenty of successful tech businesses founded during that time still dominate today.
Including Amazon. Take a look at this next chart…
The dot-com crash is almost unnoticeable on the company’s long-term price chart.
The same is true for many other companies that survived the dot-com crash – like Microsoft, Apple, Adobe, Intuit, and Nvidia.
They not only survived but went on to become industry dominators.
In other words, when the dot-com bubble burst, it did not wipe out the potential of tech or the internet.
But it did teach us that nailing a call on the future doesn’t guarantee you won’t burn cash with bad timing.
So, here’s the lesson for today.
Even though AI is revolutionary, not every AI-related company will be a good investment. Don’t rush into the hype with blinders on. And be cautious about companies with art-based valuations.
If Amazon’s story has taught us anything, it’s that in distorted times, patience pays off.
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins