This Time It Is Different – Or Is It

Whether history repeats itself, or merely rhymes as Mark Twain suggested, it is surely useful to look to the past in order to find patterns one can recognize in today’s world. One such pattern that has been on the forefront of many people’s mind in the fintech community is whether the valuations of tech companies today represent a situation similar to the dot com bubble of 1999 that ended up bursting in 2000.

In terms of context, some of the ratios and indicators appear alarmingly similar today. The difference between the S&P 500 (which represents a broad index of companies) and the NASDAQ (which is more tech driven) has now reached levels last seen in 1999. Also, the top five companies in NASDAQ now represent 20% of the value of the entire index. Another striking example is that Tesla was at one point worth more than the five biggest global auto makers combined. The list of examples can surely go on, and there are many to give from early stage valuations in the venture capital community (which are very much impacted by the public markets).

There are many solid arguments being made to support this phenomenon of skyrocketing valuations: Interest rates are much lower today than they were in 2000 so there are less alternative places for investors to park their capital, today’s tech companies actually make a lot of money, etc.

The market itself will ultimately provide us all with the answer to this question, but it would be interesting to highlight a few points that hold true from the 1999-2000 period as well as about human nature in general.

Firstly, if (or perhaps when) a crash in tech valuations do happen, it is important to keep in mind that companies with sound fundamentals will still survive, and even thrive. As an example, I remember a conversation with the team at eBay in 2002 who were at that point trying to understand the implications of becoming a bank (they did not become a bank in the end, but did end up buying PayPal). By ways of reference, eBay was one of the most successful tech companies of that era (eBay’s market cap at the time of its IPO in 1998 was $1.9bn, very close to the valuation of Amazon that also reached $2bn in 1998 after its IPO at $438mn in 1997). When asked about what they thought about the dot com crash that had happened less than a couple of years ago, the response from the team at eBay was “what crash?”

Needless to say, companies with less solid fundamentals than eBay fared worse in the crash, and many investors that had piled into various companies without asking too many questions lost a lot (and in some cases all) of their money. This brings us to the point about human nature and an interesting observation about the kinds of questions people ask and which facts they find easy versus difficult to accept.

The best way to illustrate this is perhaps with a story from the Sufi philosopher and folklore legend Nasreddin Hodja. In this story the Hodja asks his neighbor to borrow a kettle, and returns it after some time, but also with a smaller pot inside it. The neighbor who thinks that there has been a mistake returns the smaller pot to the Hodja who assures him that this is no mistake at all, and his kettle has simply “given birth” to a smaller pot during its stay at the Hodja’s house. The puzzled neighbor accepts the smaller pot and walks away. Some months later, the Hodja once again asks his neighbor to borrow the kettle who happily obliges. This time however, the Hodja does not return the kettle, and when the neighbor asks him what has happened, the Hodja simply replies that the kettle has passed away. The neighbor protests in disbelief and tells the Hodja that it is not possible for a kettle to die – to which the Hodja replies “You believed it could give birth, how is it that you cannot believe it can die?”

A 17th century miniature of Nasreddin Hodja

This story illustrates our attitudes as human beings to many a phenomenon, not least of which is perhaps life and death itself. But to stay on our topic of tech valuations, the analogue would probably be that investors are happy to believe a company, say Apple, can go from a valuation of $1 trillion to $2 trillion in something close to a year, but find it much harder to believe that the reverse can just as easily happen. An implication for us in the fintech community is that human beings are not always rational, and the valuations that reflect the behavior of said humans are by extension also not always rational. The best that entrepreneurs can do is to focus on the fundamentals of their business and make sure there is a clear path to sustainability that does not rely on capital markets always behaving in the same manner. In other words, the best immunization against volatile and unpredictable capital markets may well be the vaccination of solid unit economics!