The Total Addressable Market (TAM) is the total demand for a product or service that a company can go after. It is the estimated revenue opportunity should a company be able to capture 100% market share and sell its offering to every available customer.

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The Total Addressable Market explained.

The Total Addressable Market (TAM) Method is a valuation technique that estimates the potential revenue a new product or service can generate. It is particularly useful for early-stage companies that lack the metrics required for other valuation methods.

The TAM method estimates the overall demand for products and services for companies. By defining their market fit, companies can estimate their potential revenue. They can use various resources, such as target audience, audience size, industry reports, comparable companies, and the market share of competitors, to evaluate whether it is worth entering a market.

To enter a market, a company must determine the size of the market it can capture to forecast its potential revenue. The Total Addressable Market is the first metric to consider, as it represents the total revenue if a company had 100% market share. Since a company is unlikely to achieve 100% market share, it can work backward to determine the share it can capture and divide it by the total revenue to estimate a target revenue.

Determining the market size is crucial for companies of all sizes, as it helps them identify their potential income. The size of the market can be estimated by identifying potential customers and using an input such as Annual Contract Value (ACV) to gauge sales.

The Total Addressable Market (TAM) is also valuable to investors to not only roughly value a business but also to “proof-check” companies who use flashy presentations with massive assumptions of the target market it is going after. You can cross-check these investor luring tactics to look at the likelihood of a company’s expectations.

Why is the Total Addressable Market an important metric?

If you have worked through all the other methods of company valuation we have explored so far, you will notice they all relied on certain metrics being available. The discounted cash flow model is one such method that involves discounting future cash flow, usually starting with known inputs such as revenue and earnings to predict and determine free cash flow. If we refer to the Reverse DCF method, for companies that have negative cash flow, this method is impossible as estimating implied growth becomes too difficult and very inaccurate.

Multiples are another method but rely on earnings as a denominator, making P/E ratios best used for mature companies. Early-stage or hyper-growth companies, which often have negative earnings and negative free cash flow, are hard to value using multiples.

One way to value such companies is to use the Total Addressable Market (TAM) method. Although it’s a hypothetical way to evaluate a company, it can provide a clear picture of its potential. The TAM method helps answer two questions: “How big could this company potentially get?” and “If it does deliver to this huge undertaking, what would its potential value be?”

For established companies with a strong base of clients and optionality, we can also use the TAM method. Optionality refers to companies that can release new products and services, upsell to existing clients and customers, or even expand into new divisions or business arms off the back of their already huge market share. By estimating the revenue that new additions could bring in, the TAM method becomes a reliable way to value additional growth prospects for these companies.

It’s an important metric to businesses so it should be important to Investors. (Think like a business owner).

The Total Addressable Market (TAM) is the initial step companies and startups use to evaluate the future potential of their products and services. It provides an insight into the number of customers they can target and sets goals for the company should they decide to commit to that market. Understanding the metrics and mindset behind the companies they invest in is crucial for investors.

A company should not consider a new product or service or enter a new market until it understands the sales impact it has on that business decision. The company needs to understand the implied revenue to determine the investment made, working capital requirements, and assess the overall return on the investment to weigh up whether it is a good strategic move.

“I am a better investor because I am a businessman and a better businessman because I am an investor.”

Warren Buffett

When I was building companies, it was always best to start with the Total Available Market (TAM). This helped to identify which ideas were viable and had the most upside with the least risk.

The TAM is valuable for companies of all sizes, and investors need to understand it not only for valuation but also to assess the growth opportunities and risks for a range of companies. If a mature, well-established multi-billion-dollar organization with a huge market share says it is entering a new field, it is highly likely to deliver that growth and expansion (Think Microsoft going into the cloud with Azure).

However, if a smaller company says it is entering this market attempting to capture this size with limited resources, investors may be sceptical. They want to see a clear plan outlined before they back a business that doesn’t take bite-sized chunks of growth.

What are the differences Between TAM, SAM, and SOM?

The Total Addressable Market (TAM) can be broken into three subsets. Each one plays an important role for both the company and the investor to understand. Before we explain each of them, it is helpful to know the difference between Market Share and Total Addressable Market.

Market Share ➡️ Is the Market share that an individual company has captured of the TAM. If the TAM is $1b and a company earns $100m from that TAM, it has a 10% market share.

Total Addressable Market ➡️ is the total audience, number of customers and revenue if one company had the entire 100% market share.

Each of the below subsets is used by companies to assess the “big picture” outlook in conjunction with reality i.e. realistically we can only capture this amount.

The TAM, SAM, and SOM work in unison together to guide companies in a variety of ways. Whether it is capital allocation, where to apply focus, strategic growth planning as well as when to pull the pin.

Total Addressable Market (TAM)

TAM is the total potential market for a product or service that is used to calculate estimated annual revenue. Assuming the company wants to sell a product or service to a new market, it researches and identifies the Total Available Market as 1 billion customers. If the company has a product that costs $10 per customer, the Total Market Revenue is $10 billion in revenue potential should this company capture it all. The reality is no company captures 100% market share. The TAM is the bigger picture view of the entire landscape and the market for a product or service.

For example let’s use this blog as the example for all three (these are completely made up numbers, don’t look into it and say you are wrong, I pulled them from the air as an example). We will also leave out the implied revenue aspect and purely work on the size of the market.

The Total Addressable Market for the investment universe as a whole and those wanting to read about investing online maybe 10 billion people. This is the entire investment universe, from stocks to real estate, to crypto, everything to do with Investing blogs online. That 10 billion make up the Total Addressable Market that The Stoic Investors may outline as the “Greater Opportunity”.

Serviceable Addressable Market (SAM)

The Serviceable Addressable Market (SAM) is the component of the Target Addressable Market that a company can acquire based on the business model OR based on customers that need or want what you offer.

SAM is about realistically looking at the TAM and saying, that out of that 10 billion people, only about 1 billion want to read about (or actually read about) the stock market. The rest lean towards property investment, crypto, bonds, art, or alternative investments.

Therefore, out of the Total Addressable Market, The Stoic Investors can only service about 10% of it. So, I can only target that 10% of the TAM. SAM is essentially the exact portion of the market you want to target.

Serviceable Obtainable Market (SOM)

The final subset is the Serviceable Obtainable Market (SOM) which reflects the percentage of the SAM that a company can realistically capture and service. Whether based on competitive positioning, existing market share or the anticipated growth within the SAM. The obtainable market is more related to the SAM, as that has outlined the “real opportunity” within the “greater opportunity”.

So going back to our example, if I think I can, or do capture 10 readers in total (including myself and my wife), I will have a SOM of about 0.000001% of my SAM. Sounds thrilling! If I did capture 100 million readers, then I would say my current market share of the TAM is about 1%.

The SOM is the most important metric to be honest about. This is the starting position for companies. This implies the company can keep its current market share and slowly grow it into the future.

The steps followed above in more detail of course are how TAM valuation works. In simple terms.

Total Addressable Market ➡️ Identify the big-picture outlook and the total size of the opportunity.

Serviceable Addressable Market ➡️ Realistically identify the market you can deliver to and who wants your offering.

Serviceable Obtainable Market ➡️ Your current market share of the SAM and what you can deliver to right now.

Combining revenue forecasts with a top-down approach helps to narrow down assumptions, providing a rough valuation for a company’s starting base.

What type of businesses are best suited to TAM?

As mentioned earlier, TAM valuation is best suited for smaller companies that are yet to earn profits, have not broken even and have a long way to go before reaching the threshold of profitability. This valuation method is suitable for hyper-growth companies that are scaling up and those that do not follow traditional valuation methods.

For larger companies that have already established themselves, we will discuss optionality in a separate article. However, TAM valuation can be used for mature companies that are expanding into new markets or introducing new products. For instance, an EV company that wants to expand into lithium batteries can use TAM valuation if they have an established customer base, manufacturing capabilities and enough cash to execute their strategy.

TAM valuation is mostly used in the micro-cap and small-cap space, and it is helpful in two ways. Firstly, it helps evaluate a business’s growth prospects and future potential, and secondly, it allows us to compare a company’s expectations with actual potential. This valuation method can protect investors from being carried away by fancy investor presentations and glossy charts that claim to offer the next big opportunity.

Although TAM valuation is a hypothetical valuation model and probably the most inaccurate, it is still a great method as part of a fundamental investment process when evaluating new ideas.

When evaluating expensive-looking growth stocks, TAM can be a powerful way to help justify the price. If I believe the Serviceable Addressable Market is much bigger than the SOM and I believe the company has the ability and the resources to execute on growth, then that helps to position an “expensive” stock in a different light.

Resources and Researching Total Addressable Markets.

When attempting to assess a company’s value using the Total Addressable Market (TAM) method, it is crucial to gather accurate data and use reliable resources. There are two common reasons for using the TAM method, both requiring the same process: To verify a company’s TAM and forecasts or conducting your own assessment of a company’s potential market size.

For example, take AirBnb and the image below that was used in the investor pitch presentation. TAM is 1.9 billion of trips booked the “big opportunity” that draws in investors. The SAM is 532 million potential bookings within the business model. Then the final 10.6 million is the current SOM. When you see this, investors think “Wow, what a massive opportunity”. Investors need to verify all of these projections and not get caught up in the “What if”.

To find the necessary resources to make your assumptions, it is essential to know where to look. The first step is to confirm the customer base that the company has either stated or that you have identified. Use government data, industry data, and available market research online to confirm the audience, geography, demographic, and final customer count.

If there are public comparable companies (competitors), look at their forecasts, the TAM they have outlined, and their market share. This can reinforce the TAM by looking at what other companies have forecasted. If a company says it can achieve a TAM that is smaller than your target company, then something is likely off.

Once you have gathered all your research and started laying out some numbers, you want to start running some cross-checks and analyzing each of the assumptions and their likelihood. There is an abundance of information and data out there.

The Stages to developing a TAM assumption.

Half of the investment process is just surfing the internet, researching, doing investigative journalism work. You are a detective most of the time, and an investor the least amount of time.

TAM is grounded in deep investigative scuttlebutt work.

Always Trust but Verify
Understanding the company, the business model, the products and services is the first step. Get an idea of why customers are choosing this product or service or may want to choose it. Look at the sales process to help understand the likely hood of this company servicing a bigger customer base.
Look within the annual report, look at all the assumptions from the company. Whatever graphs and hypothetical assumptions are being stated. Most public companies outline what they see as their TAM, SAM and then SOM. Find out what they are.
Competitors that are listed is the next comparison. Look at the forecasts, the addressable market assumptions they have made. Compare it all. Cross check against not only their revenue estimations but the size of the market, the total revenue, the total opportunity.
Seek expert advice within the industry. You can reach out to people on the internet or within the industry to understand it in detail. There will be experts in every field, find them, email them and ask.
Industry and Market data/reports are very helpful. There are many trusted resources that publish accurate statistics, industry reports, geography analysis, you name it, it is out there. Look at Government reports especially when it comes to demographics.
Once you have gathered all the date and laid it all, you will have a big picture view of the opportunity and hopefully a realistic view of the likelihood of the company executing to the target market.

Various Total Addressable Market methods to Value a business.

There are 3 approaches used to determine the addressable market opportunity of a business. Each is outlined below.

Top-Down

The Top-Down approach involves gathering data from various sources such as industry reports, market studies, and government resources to identify the total market opportunity. This process takes a macro view of all the factors involved and then narrows down to create a Total Addressable Market.

This approach is particularly useful for new markets where identifying the target audience is still in the early stages. The process begins with determining the number of people or businesses in the market, and then breaks it down further based on criteria such as geography, demographics, etc. The process of elimination continues until the target market is identified.

A simple way to calculate TAM using this method is to use the following formula.

Total Market Size x Average Spend per Year Per Customer = TAM

Assuming you want to find the TAM in South-East Asia for people who use fitness apps. You use resources and industry reports to conclude that across a range of apps, there are 250 million downloads. The average subscription spend per customer per year is around $40 USD. You would then work it out as followed:

250 million Customers X $40 Average Annual Spend = $10 Billion TAM

You may build a SOM estimation based on this by saying I can capture 5% of this market with an estimated revenue to capture of $500million.

Bottom-Up

The bottom-up approach is a more reliable method that is grounded in real data and primary research. It involves extrapolating certain assumptions by taking the desired target market on a smaller scale and expanding upon this to the total market. The bottom-up method inverts the top-down idea, by often starting with the ideal target market and builds upon this.

This method is often used after conducting a Minimal Viable Product (MVP) on a small set of potential customers. The results are then used to build upon and apply to the entire target market as a whole.

The bottoms-up approach is more accurate because it is based on either existing data or experiments it has undertaken, which are most commonly generated in-house. The results are then used for forecasting into the TAM or a portion of the SAM.

To work out TAM using a bottom-up method, you multiply your average sales price by the total number of current customers. This is known as the ACV Approach (Annual Contract Value).

Annual Contract Value (ACV) X Total Number of Customers

For example, let’s assume you are selling accounting software, and you identify there are 48,000 accounting firms within your target market. You currently have 1,000 clients paying $29.9 a year.

Our ACV is 1,000 customers x $29.9 = $29,900

Multiple this ACV by the Total Estimated potential of the market.

$29,900 x 48,000 Accounting Firms = $1.43 Billion TAM

Value Theory

Assessing the value of a product or service and determining how much a customer would be willing to pay for it is a challenging task. This involves estimating the value that a company provides to customers and then reflecting that value in the pricing of the product or service. However, the Value-Theory approach, which is largely speculative, is not very accurate for investors. It can be helpful for companies with significant product differentiation.

It is essential to understand a company’s product and innovation to determine its value accurately. Although it is easy to determine the value of a product or service in hindsight, such as streaming services, EV cars, mobile phones, and social media, identifying this value before the fact would be difficult for common investors.

Companies run this exercise, but they have a far greater understanding of what they are trying to do, which is sometimes not reflective of what we can assess. Finding product differentiation and product fit takes time. It is a good exercise to comprehend a company’s product and innovation rather than aiming for a specific valuation or number.

An example using a TAM method to value a business.

I don’t spend too much time trying to determine a company’s future market value using this method, as it is not very accurate. However, we can still use an example to illustrate how it works.

There is a formula we can use to estimate a company’s future market cap. This formula typically uses TAM (Total Addressable Market) as the input. However, I prefer to use SAM (Serviceable Available Market) as it represents the real opportunity for the company to target. For instance, an EV (Electric Vehicle) company will not target the entire automobile industry TAM. Instead, they will focus on the addressable market of people who want a personal electric car.

The formula to determine the estimated future market cap of a company using the TAM formula is as follows:

SAM x Market Share % x Earnings Margin x Future Multiple = Assumed Market Cap

This formula is not perfect, but it can be helpful in putting some companies into perspective that have been delivering and have the foundation to execute their growth plans. This formula should never be used for investment decisions on the basis of the output. It is just a guide to how big a company could grow into.

An example using the formula:

For example, let’s assume a company is targeting a sector that has a TAM of $50 Billion in total value. It believes the SAM within this TAM is approx 5% which means the real opportunity for the company is $2.5billion in revenue to target.

It believes it can capture a 20% market share within that subset of the Total Available Market.

You would estimate the profit margin of the company, being very conservative with this estimation, comparing to real data and like-for-like companies. Assuming 15% profit margins. We would then look at the multiple the company has now, then how it may contract or expand in the future. Let’s assume it will grow into a comparable company with an average P/E multiple of 18x over ten years.

The company has a current market cap of $250 million.

Let’s put all of this together.

SAM = 5% of $50billion = $2.5b

Market Share = 20%

Net Profit Margin = 15%

Future P/E Multiple: 18x

$2.5b x 20% x 15% x 18 = $1.35 billion

The formula implies that if the company delivers on the forecast of its SAM, captures that 20% share, over time creates a profit margin of 15% and maintains a multiple of 18x, hypothetical the future value may be around $1.35billion.

This takes me about an hour to work out and is simply a guide. There are way too many assumptions and unknowns to suggest accuracy.

I would simply compare the expected value with the current value, look at the likelihood and milestones needed to achieve this, and for the risk ensure there is a lot of upside to justify the investment.

I’m used to this method, because of my involvement in building companies in the private sector. It was often the only method we could use.

In Summary…

The accuracy of inputs and assumptions that the company delivers as planned are the downsides to this valuation method. As I’ve mentioned before, valuation involves a lot of “ifs”. For example, if the company can grow into a certain market share, it may have an implied revenue of $x. I use the TAM method not to determine a per-share price for a company, but rather to assess its potential and determine how much upside it has. Then I run it through some checks and think about each of the outcomes.

My experience as an entrepreneur and building companies gives me a certain degree of scepticism when it comes to smaller companies with inflated expectations. I cannot help but think like an owner.

I’ve had a lot of conviction about smaller emerging companies by understanding the available market ahead and the reality of the serviceable market. This allows me to compare where the business is in terms of size and what’s needed to achieve the end outcome. If a small-cap company is undervalued, has great fundamentals, and the TAM/SAM is realistic in what I believe it can grow to, and the 5-10-year future implied market cap is 5-10x the current size, I pay close attention.

It’s also important to know the metrics to track the progress of growth. Whatever it may be, sales growth, customer acquisitions, subscribers, users, or any other metric, we have to closely follow it to see how the company is performing and growing its market share.

Whilst this is not a definitive deep dive into TAM valuation methods should hopefully give investors enough to explore the idea further. There is a time and place for each valuation method and as long as you understand when and how to apply it, it can be beneficial.