Sometimes, spotting a bubble is very easy. Imagine three public companies that make shoe leather—Derek Leather, Inc., Joe Leather, Inc., and Becca Leather, Inc.—with the exact same revenue, expenses, talent pool, and customer demographic. Let’s say the market caps for all three companies start the year at $1 billion and Derek Leather and Joe Leather don’t appreciate; meanwhile, the public valuation of Becca Leather climbs to $2 billion, then doubles to $4 billion in a month, and then doubles again to $8 billion in the following week. It would be pretty clear that Becca Lather’s valuation makes no sense with an apples-to-apples comparison to Derek and Joe.
But what happens when an entire industry is a bubble? It becomes harder to make an apples-to-apples comparison, since the entire sector is an incomparable fruit. A good example would be early Internet companies whose valuations soared in the late 1990s and crashed in the dot-com bubble. For years, Internet bulls defended the stock prices of companies like Pets.com by arguing that, due to the rising digitization of the economy and the global nature of the Internet, user growth was a more significant proof of value than old-fangled metrics like profit or revenue. Eventually, a combination of factors—the failure of some large Internet companies, changes to the tax code, rising interest rates, and venture capital exhaustion—contributed to the big pop.
Join the conversation as a VIP Member