In this world we have something existing called a land grab. There is only so much of it (land) and depending on what type of land, it creates a rush. There is only so much beach along the ocean. There is only so much land around a lake. There are only so many plots with that great view of the mountains. Every major urban area has an “it” area to live. You get the gist. Except in investing, you don’t really know how much beach there is or the size of the lake.
Investing in innovation has a similar idea called TAM, Total addressable market. TAM refers to the size potential of an area of investing. What is the size of the population that can use or be served by this innovation and how much money could it make? Whether it is a technological innovation or a pharmaceutical’s drug/therapy, a lot of number crunching is keyed off of the TAM. TAM is not a certainty, but a very educated estimation.
One issue with TAM is there are other factors involved too. TAM’s importance is one can take TAM, multiply by $$ and come up with a potential revenue, whether it’s a subscription, a prescription, or repeatable service. However, there may be other factors keeping the great TAM story from coming to fruition. Perhaps insurance or Medicare won’t pay for it. Perhaps it is anticipated to be a world changing technology and ends up being a glorified spell check, grammar check, and search engine. Perhaps it is an EV company benefiting from government subsidies and low interest rates and now has competitors. Perhaps it is a company dependent on employees being 1099 instead of W-2. You get the idea. All “land grab” stories have inherent risks. If everything doesn’t go just right, you end up with desert property instead of beach property.
What is the point? While the TAM narrative is about as sexy as one can find, making it to the end point unscathed is actually a rare event. While there are companies that can be pointed to as success stories of TAM, they are what we call “survivorship” bias. There are many similar and related companies that failed along the way to the destination. Let’s look at an example.
Lucent is no longer around. They were part of AT&T (when it was forced to split into pieces). No one could imagine this technological giant in telecom not existing (hello? AT&T?). In fact, they and a few other non-existing companies are responsible for a lot of the fiber network we all enjoy today making our internet. Carly Fiorina was president of sales at Lucent and in an aggressive tactic to boost sales, lent money to vendors to buy Lucent equipment. Sales sky rocketed, but it exposed Lucent to balance sheet risk in that the loans were only as good as the companies they were lending. When the fiber optic land grab came to a screeching halt in early 2000’s, Lucent was the bag holder. The company that once was AT&T’s technology division got bought by a competitor who eventually wrote down most of the merger as it failed. Shareholders enjoyed a meteoric ride on the way up in the story. Many initially were long time owners of AT&T who accidentally ended up with this Lucent thing. But as the telecom bubble grew, *everyone* wanted to own it. And Nortel, Alcatel, Corning, JDSU, Brocade, and many others that either don’t exist as a self standing company or are a shadow of their former self.
These things happen and will continue to happen because we are humans. We get excited about a story that will change the world. We buy the companies involved up to unsustainable prices based on unsustainable growth expectations. Then things come back down to Earth. Everyone wants the ride up. No one wants the ride down. But bubbles can’t be prevented because our human nature drives it.
Here is how we can help you: We can prevent ourselves from getting too over exuberant about these TAM stories. We can apply a disciplined approach to building portfolios and investing. We can have some exposure to these companies thru the investment process, but not chase them. We can control their size in the portfolio. It is virtually impossible to avoid their effects—and I’m not sure you want to because these things happen naturally all the time and are part of the stock market eco-system. These stories are what keep people involved with investing. It is part of our human nature reflected in the stock market.
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