IMAGE: Eduardo Huelín — 123RF

Welcome to the bubble economy

Enrique Dans
Jan 17, 2016 · 3 min read

I was contacted earlier this week by Raquel Quílez, from the Spanish daily newspaper El Mundo to sound out my views on talk of a financial bubble emerging in Silicon Valley, so, for non-Spanish speakers, I thought I’d include a few of my comments here. The full article can be found here: ¿Va a estallar Silicon Valley? (“Is Silicon Valley about to explode”, pdf in Spanish).

As I have pointed out in numerous articles over the last decade, bubbles are now an integral part of the economy, appearing from time to time, depending on certain variables. What we need to remember is that not all bubbles are the same. For example, the dot.com bubble of 15 years ago — inflated by unfulfilled performance expectations of companies that were clearly overvalued — has nothing to do with the present lively effervescence in the tech sector.

That said, it’s clear that many companies are overvalued at the moment from a financial perspective, even based on revenue multipliers or time weighted cash-flows. But this isn’t the case with all companies: Uber’s valuation, published by Aswath Damodoran, which used different scenarios based on its business divisions. When a company has shown its ability to generate revenue, has put its business model to the test and is generating cash flow steadily, basing valuation on the basis of it expanding its activities into related areas or its ability to steal the market share of companies susceptible to replacement are not exactly the best grounds for arguing the existence of a bubble.

A bubble characterized by the absence of earnings around which a value model has been built is not the same as one in which companies inflate their value to attract shareholders. A company like Snapchat, for example, based its early valuations on what shareholders saw in the potential of its team and its product to position itself in the adolescent market, then supported that valuation through Facebook’s interest in acquiring it, and has since further increased that valuation as it shows its ability to create services able to generate cash flows. It would seem reasonable to assume that its shareholders are not idiots nor likely to be sucked into a bubble way of thinking. That said, it is possible that these so-called unicorns, characterized by potential high growth, will create valuation bubbles based simply on supply and demand at a time when many investors are looking for opportunities to invest in them, thus overheating the market.

The days of quiet markets have gone. Today, every innovation, every disappointing quarterly results, every major revelation or biased analysis can set in motion a domino effect that is going to leave a lot of people out of pocket. We live in a hyper-connected world in which information moves way too fast to be able to properly process it.

In a market where technology and entrepreneurs are constantly creating new opportunities, there is no avoiding the bubble tendency; what’s more, there’s nothing inherently wrong with such a volatile environment: it’s just a sign of the times. True, these bubbles can be dangerous places for the unprepared or unwary — many tech companies are little more than startups, and thus subject to the same Darwinian laws of survival that have always applied to the markets — but that is no reason to dismiss an entire industry as a bubble. Nevertheless, as with everything in our hyper-connected, light-speed world, there is always the risk that the bubble will burst.


(En español, aquí)

Enrique Dans

Enrique Dans

Written by

Professor of Innovation at IE Business School and blogger at enriquedans.com

Enrique Dans

On the effects of technology innovation on people, companies and society (writing in Spanish at enriquedans.com since 2003)

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