Totally Addressable Markets (TAM) are at the heart of what Charlie Munger calls the biggest euphoria episode he has ever seen in his career. We believe that the coming stock market failure emanating from the over-pricing of the U.S. stock market is closely tied to TAM. What is a totally addressable market? When is it useful to think about TAM? Answering these questions could tell us a great deal about where to be invested in the common stock market over the next five years.

Here is how the Corporate Finance Institute defines a Total Addressable Market:

The Total Addressable Market (TAM), also referred to as total available market, is the overall revenue opportunity that is available to a product or service if 100% market share was achieved. It helps determine the level of effort and funding that a person or company should put into a new business line.

The concept of total addressable market is important for startups and existing businesses because the estimates of effort and funding required allow them to prioritize specific products, customer segments, and business opportunities. Where there are potential investors and buyers of the business, company executives can use TAM to provide a viable value proposition.

The best way for us to explain a TAM is to think of the bottled water business. There are 7 billion people in the world and they all require water. If we start a bottled water company and make one million bottles of water at a dollar per bottle and sell them for $0.90 per bottle, we’d have $900,000 in revenue. In the second year, if we make 2 million bottles of water at a dollar apiece and sell them for $0.90 per bottle, we’d have $1.8 million in sales and have grown our revenue 100%. Investors over the last few years would have flocked to our stock market debut as they salivated over 100% revenue growth and an addressable market of 7 billion people.

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