Capitalizing Potential

A massive amount of stock market capitalization is tied up in companies based on both their potential market share and hypothetical future profits. The popular arguments in their favor come from looking at a company’s total addressable market (TAM). Sky high price-to-earnings ratios and massive capitalizations are common in companies with a large TAM as we finish up 2017.

We thought this would be a good time to delve into the concept. What is a TAM? Why is it so popular in today’s stock market? Are there realistic business arenas where the long duration value manager can invest based on total addressable markets that are in the early stages of being fulfilled?

We will give you an example to help explain TAMs. There are approximately 7.6 billion people in the world. To understand the theory of TAM, you first need to think about what portion of people could possibly be a customer of a business. In a perfect world, these people would all eat three meals a day. In that case, if you are in the business of selling meals, your TAM is 22.8 billion meals per day in a perfect world.

McDonald’s (MCD) is one of the greatest success stories in the history of U.S. business and serves one percent of the meals eaten in the world each day. Big Mac trades at 26 times after-tax profits, a healthy multiple, but reasonable if you think they could reach another 76 million people. Also, McDonald’s covers their existing market very profitably, but growth from their size has been relatively hard to come by in the last five years.

Today’s glamour tech stocks like Amazon (AMZN) also have huge total addressable markets. Amazon looks at total retail sales in the U.S. of $5.8 trillion and drools while they wonder what part of it they can get. Amazon had $80 billion in online commerce in North America last year. Jeff Bezos, the CEO of Amazon, has done a great job leading investors to measure his work based on market share in their online commerce rather than on profits. In this way, he leaves them a lot of room to fantasize about what seems like open-ended TAM possibilities.