Not all growth stocks are created equal. Some operate in massive, untapped markets with room for exponential growth, while others see their growth capped because they’ve become a big fish in a small pond.
Tesla and Shopify both thrived because they dominated massive and expanding markets, which gave these companies lots of room to grow.
Understanding a company’s Total Addressable Market (TAM) can help investors understand how big a business can grow and what kind of returns a stock can deliver.
In this article, we’ll dive into how you can apply the concept of TAM to find companies with massive growth runways.
What is Total Addressable Market (TAM)?
The total addressable market is the total revenue a company would generate if it captured 100% of the market it competes in.
It’s a key metric for assessing a company’s growth potential and is often used when investors are looking at high-growth businesses.
Why TAM Matters
A large and growing TAM gives a company the runway to scale over time. However, a business operating in a market with a small TAM might have limited opportunities.
If a company already captures a significant share of its TAM, its growth potential may be constrained.
For example, Tesla operates in a massive and expanding total addressable market that goes beyond electric vehicles, tapping into renewable energy and autonomous driving. This gives the company multiple avenues for growth.
In contrast, a niche company like a regional grocery chain is limited to a much smaller TAM. It is confined to serving a specific geographic area with minimal room for expansion without opening a new location.
This difference in market potential highlights why Tesla has been able to scale so aggressively while companies with small TAMs often face growth ceilings.
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How to Calculate TAM
Here are three of the most common methods to calculate a company’s Total Addressable Market:
- Top-down approach
- Bottom-up approach
- Value-Theory approach
The Top-Down Approach is the most commonly used method to estimate the market size for large businesses.
However, the Bottom-Up Approach is often the most accurate.
Top-Down Approach
The top-down approach uses industry-wide data to estimate the potential market size for a specific company. This approach starts with the total revenue of the company’s industry and refines the estimate based on the company’s specific niche.
For example, Statista estimates that revenue in the global e-commerce market will reach $4.8 trillion in 2025.
Since Shopify (SHOP) serves small and medium-sized businesses, you could estimate that Shopify’s TAM is a percentage of that $4.8 trillion. Shopify is expected to see nearly $9 billion in revenue for fiscal year 2024, so this suggests that it still has a long growth runway.
Most public companies will assess their TAM using this approach, as it’s a simple way to estimate the market potential for massive businesses.
Bottom-Up Approach
The bottom-up approach estimates TAM from the ground up by estimating the number of potential customers for a company and the potential revenue per customer.
As an example, imagine a cloud storage company that targets freelance professionals, such as photographers, designers, and writers.
Say there are an estimated 2 million potential customers in this niche, and the company charges $100 per month for its cloud storage and design subscription service. This would result in $1,200 in annual revenue per customer.
2 million potential customers at $1,200 in annual revenue per customer would result in the company’s Total Addressable Market being $2.4 billion.
This bottom-up calculation provides a clear view of the market size based on specific customer segments and pricing. This calculation method works best for smaller businesses with single product lines.
You can imagine how this kind of exercise would be challenging for a business with multiple products and customer profiles, which is why the top-down approach is the most common.
Value-Theory Approach
This approach estimates TAM based on the value or the cost savings a product provides.
For example, a solar panel company could calculate its TAM by estimating the value of electricity savings it delivers to households over the lifetime of its panels.
For instance, if the average household saves $20,000 in energy costs over 25 years and there are 50 million homes suitable for solar installation, the TAM would be $1 trillion ($20,000 × 50 million).
This approach makes the most sense for companies that deliver significant cost savings, usually through disruptive technologies. Investors can assess the cost savings a product would deliver and estimate how many potential customers there would be.
Pro Tip: When using the value theory approach, it’s important to make sure that the assumptions are realistic and based on actual customer behavior rather than overly optimistic estimates.
Factors That Influence TAM Size
Market Growth Rate
The TAM for a product or service can expand rapidly if the underlying market is growing. High-growth markets attract new customers and create opportunities for companies to scale.
Example: The cloud computing industry has grown at a double-digit rate over the past decade, enabling company divisions like Amazon Web Services and Microsoft Azure to increase their TAM significantly.
Pro Tip: Look for industries with strong annual growth rates, like renewable energy, artificial intelligence, and e-commerce.
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Geographic Expansion
A company’s TAM can increase when it enters new geographic markets. Expanding internationally or tapping into underserved regions can unlock additional revenue potential.
Example: Netflix’s TAM expanded dramatically when it launched in new countries, growing its subscriber base beyond the United States.
Innovation and Disruption
Innovation can create entirely new markets, effectively growing TAM overnight. Companies that introduce disruptive technologies or products often redefine their industries and create new opportunities.
Example: Apple’s launch of the iPhone redefined the mobile phone market, vastly expanding the TAM for smartphones and creating opportunities for app developers, accessory makers, and more.
Common TAM Mistakes to Avoid
Overestimating TAM
Some companies present overly optimistic TAM estimates by including markets or customer segments they are unlikely to capture. This can lead to unrealistic growth expectations.
Example: A niche software company might claim a TAM based on the entire global software market, even though its product is only relevant to a small subset of users.
Pro Tip: Cross-check the company’s TAM estimates against industry reports and competitor data to ensure they are reasonable.
Ignoring Addressable Market Limitations
TAM often represents the theoretical maximum market size, but it doesn’t account for real-world limitations like competition, customer preferences, or regulatory barriers.
The Serviceable Addressable Market (SAM) and Serviceable Obtainable Market (SOM) help to show a more realistic picture of a company’s total addressable market.
The Serviceable Addressable Market measures the total value of the market that a company can sell to based on the products, services, and capabilities it offers.
The Serviceable Obtainable Market narrows down the market a bit further from SAM and measures just how much of the market the company can realistically win, given the market’s competition and the business’s operational constraints.
Example: While Tesla’s TAM for electric vehicles is large, the actual addressable market depends on consumer adoption rates, pricing, and government incentives.
Relying on Outdated Data
Markets evolve, and TAM estimates can quickly become obsolete. Relying on old data can lead to incorrect assumptions about a company’s growth potential.
Example: A TAM analysis for traditional retail from 10 years ago would probably have underestimated the impact of e-commerce on consumer spending. Therefore, it can be helpful to use the latest industry reports and analyst estimates to ensure TAM calculations are up to date.
How to Use TAM for Investment Decisions
Pair TAM with Revenue Growth Metrics
A large TAM is only valuable if the company can grow its revenue to capture a meaningful share.
It’s best to see a company growing its revenue faster than the rate its total market is growing.
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Consider Competitive Positioning
Even in a large market, intense competition can limit a company’s ability to grow.
Investors can assess a company’s market share and competitive advantages to gauge its potential.
Example: Despite its large TAM, Peloton faced challenges as competitors entered the connected fitness space, limiting its ability to grow and capitalize on its TAM.
Pro Tip: Evaluate whether the company has a clear competitive moat, such as proprietary technology, brand loyalty, or network effects.
Evaluate Management’s Growth Strategy
A company’s ability to capture its TAM depends heavily on its leadership and strategic execution. Strong management teams can identify new opportunities and scale effectively.
Example: Amazon’s management consistently identified and executed on growing into adjacent markets, such as AWS and logistics, to expand its TAM and drive growth.
Pro Tip: Review the company’s investor presentations and earnings calls to understand its long-term strategy for growth and TAM expansion.
Frequently Asked Questions (FAQs)
1. What is a Total Addressable Market (TAM)?
TAM represents the total revenue opportunity available for a product or service if it captures 100% of its market. It’s essentially a way to measure how big the market is for a company’s offerings.
2. How is TAM calculated?
TAM can be calculated in three main ways:
- The top-down approach starts with industry data and narrows it down to the company’s target market.
- The bottom-up approach estimates the number of potential customers and multiplies it by the revenue per customer.
- The value-theory approach assesses the value the product delivers to customers and estimates how much they’re willing to pay.
3. Why is TAM important for growth investors?
TAM helps growth investors gauge the size of the opportunity a company is chasing. A large and growing TAM shows that the company has significant potential to scale and capture more revenue over time.
4. What are common mistakes when analyzing TAM?
Some common pitfalls include overestimating TAM by including unrealistic markets, overlooking competitive or regulatory constraints, and using outdated data. Accurate TAM analysis requires realistic assumptions and up-to-date information.
5. How do you use TAM in investment decisions?
TAM is most useful when combined with other factors, such as revenue growth trends, competitive advantages, and management’s strategy. Together, these elements provide a fuller picture of whether a company can capitalize on its market potential and sustain long-term growth.
TIKR Takeaway
Knowing how to calculate a company’s Total Addressable Market (TAM) helps you see if a company has room to grow year after year.
Using TAM, alongside other tools, can help you make smarter investment choices and find businesses with real potential for long-term success.
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Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. We aim to provide informative and engaging analysis to help empower individuals to make their own investment decisions. Neither TIKR nor our authors hold any positions in the stocks mentioned in this article. Thank you for reading, and happy investing!
