How to Think About TAM

In this episode of MarketFoolery, Chris Hill and Motley Fool senior analyst Abi Malin go through the latest headlines from Wall Street. They start their discussion with the record retail sales figures for May and then take stock of the fitness industry. They end the show by taking some listeners' questions.

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This video was recorded on June 16, 2020.

Chris Hill: It's Tuesday, June 16. Welcome to MarketFoolery. I'm Chris Hill. With me today it's Abi Malin. Good to see you.

Abi Malin: Thanks for having me.

Hill: We're going to talk about the business of exercise. We're going to dip into The Fool mailbag, but we're going to start with retail. Because retail sales for the month of May came in nearly 18% higher than the previous months. That is a record. Even if you bake out auto sales, that's also a record. Although, every once in a while, [laughs] we talk about businesses that, you know, maybe like a struggling retailer, and they had a good quarter and we talk about their same-store sales growth. And we say, yeah, it was off of a low base. This is great to see, but this is in comparison to the retail sales we saw in April, which were quite low.

Malin: Right. I do think we should make that caveat. So, it is still below COVID or pre-COVID levels. So, spend was about $486 billion in May, and spend in February, so pre-COVID, pre-shutdown, the spend was about $527 billion. So, we are low on a historical looking back perspective, but it is marginally better. [laughs]

Hill: Marginally better, although, you know, there are a couple of categories that, even if you go back pre-pandemic, you compare them to what we saw in January and February, they're up solidly. You know, it's not a big list, but not surprisingly, e-commerce just continues to be incredibly strong, again, not just compared to April, but even compared to pre-pandemic months.

Malin: That is true. Online sales were up almost 78% in May, according to Adobe Analytics. And I think that number makes sense, and I think it's something that we're going to continue to see even as stores open up and retail footprints reopen, I think we're going to continue to see a fair amount of online sales.

Hill: We've talked about this before with the major retailers, like Target and Walmart, but I'm curious if you think -- you know, both of those businesses have done such a great job with pickup, with basically just enabling, sort of, syncing what they're doing with online, with the physical stores. I have to say, I've been impressed, particularly with Target, just as a customer what I've seen with their ability to -- you know, there have been times, over the past couple of months, where I've gone online, I'm looking for something. And they're like, "Well, it's not at the location closest to you, but it's at this one a little bit ... " you know, and they are great, they've really done a great job.

I'm curious if you think we're going to be seeing that across the board, if that is now table stakes for all retailers, like, it's not just you have to have e-commerce, you have to have it synced with your physical stores so that you can enable pickup.

Malin: Right. I think you're getting to even a bigger problem here, which is really your customer service management. And so traditionally with retail brick-and-mortar stores, you find someone in the store, right? But as things shift more online, we've seen a lot of retailers speak out about that challenge. So, it's Macy's, Wayfair, Best Buy, IKEA, Lululemon, they've all said that they've had pretty significant issues in terms of customer service and customer relationship management. And so, Salesforce, who is one of the largest sellers of customer relationship management software, said their weekly customer service chatbot sessions for retail and consumer goods clients have increased 4X since the end of February.

So, I mean, again, right, the number is staggering, right? [laughs] So, it's crazy.

Hill: [laughs] I knew you were going to go with a big number, I didn't think it was going to be a 4X number.

Malin: Right. I think the way consumers have shopped is going to change, I also think the more that we shop online, there is statistics, and I think we're going to get better about this as a community or as a country or whatever, however you may want to phrase it. But as people shop online, traditionally what we've seen is higher rates of return, particularly, in apparel. So, you try something, you don't really like it, you send it back, whatever.

For brick-and-mortar stores and traditional retail plays, that poses a lot of issues with inventory management, just logistically it's a problem. So, I think you're right. I think Target is on the forefront of being, sort of, logistically better, but I think all retail stores still have a pretty long way to go before we can say that we're safely in the woods.

But I guess I would add, I think the bottom-line of this report, and the thing that people are anchoring to, the thing to get excited about here is that any increase in consumer spending reflects an increase in consumer confidence. And so, this data would suggest that people are less worried about losing jobs and less concerned about saving more than they have in the past. And that's probably encouraged by the recent job report, but generally speaking, we're starting to see a little bit of economic recovery. It might be early, it might not last, but it is encouraging data.

Hill: Let's move on to the business of exercise. 24 Hour Fitness is one of the largest chain of fitness centers in the U.S. They've got more than 400 locations across America. And that is about to change in a big way, because 24 Hour Fitness is closing 130 locations and filing for bankruptcy.

This is a privately owned company, Abi, but when I saw the story, I immediately thought of Planet Fitness. And I was surprised to see that shares of Planet Fitness are only down 5% year-to-date, that seems like a massive -- how is that -- as we've seen the rise of Peloton, both, as a business and as a stock, are you surprised that Planet Fitness is only down 5% year-to-date?

Malin: It's a fair question. I mean, in that filing for 24 Hour Fitness, they did write, if not for COVID-19 and the devastating effects, the company would not have had to file. So, certainly this is a result of this pandemic and of these gyms being shut down.

And I think it is a valid question for Planet Fitness. So, certainly, as things are opening up again, we just talked about it, it's positive, but I don't think consumer confidence to spend money is necessarily equivalent to consumer confidence being feeling great about getting back to a gym. So, even if they are able to reopen their doors, if I were a shareholder, I would be watching to see their churn rates.

I think the one thing that Planet Fitness does have going for it that I think is encouraging, they did put all of their memberships on hold while their clubs are closed, which I think is really positive. And you know, their memberships are pretty inexpensive. So, about $10 a month, they have more than 14 million members. And they target the 80% of the U.S. population who is over 14 and are not avid gym goers or avid fitness people. So, it's sort of a low-cost approach in an industry with a lot of options. And I think, because they're so low-cost, there might be some ability to remain, kind of, sticky even if people don't actually show up, they might pay that membership fee versus something, you know, if the fee was much higher, I would be a little bit more concerned that people would be ready to cut the payment quicker.

So, I think there's a little bit of leeway with Planet Fitness, but I think, certainly, if people are comfortable going back to the gym for, you know, six months or a year, I think it's a valid question, right?

Hill: You know, it's interesting, because until you just said what you said, I hadn't really thought about, sort of, the offerings at Planet Fitness, because certainly there are fitness centers and gyms that offer a lot of classes, some of those classes involve, sort of, like circuit training, where it's like, you know, you got 15 people and you're going to 15 stations. Like, I don't see how those types of classes continue. I do think that maybe a Planet Fitness is in better shape, no pun intended, just because it's much more straightforward, it's much more, you're going to use this machine, you're going to use this one treadmill, you're going to wipe it down or we're going to have a staff member wipe it down before and after. And there's not as much sharing. You know, they're not as dependent on, no, this is a spin cycle class and we need to fill it with [laughs] as many bikes as possible. So, they're going to be spin classes, they're just going to be a lot fewer people in them.

Malin: Right. I think that is a good point. And I think also, you know, they have rolled out an app, they do have virtual workouts for their members. They're doing everything right. I just think the future outlook of fitness is certainly questionable, and I mean, you mentioned circuit training, that's what I do actually, I go to something called F45 and so you rotate through all of these stations.

And my gym is so close, but they are making a bunch of adjustments when we reopen. And one of the things is, in a class that normally has 30 people, they're limiting it to 10. And we're no longer rotating through, you just use your weights and your equipment in your spot for the entire session. But I have to think, you know, that pressures margins, right? In a class where you normally have 30 people, if you can only fit 10, that's challenging, especially in a high-traffic area, like D.C., where everyone is trying to get in their workout. I go at 6 a.m., so. And those classes fill up within maybe two hours of being posted online. So, I don't know how you serve the same amount of people when you need exponentially more space.

Hill: Well, and that's the thing, that from a customer standpoint, it's like, if you're still able to get in a class, ideally you want it at the time you want, but if you're able to get in a class, you make the adjustment and there are fewer people in there. So, if it works out timing-wise, it's better for the customer. As you say, far worse [laughs] from a business standpoint for the gym.

Malin: Right.

Hill: Our email address is [email protected]. Question from Luke Frandrup in Minnesota. Luke writes, "I'm a longtime Fool reader, subscriber and podcast fan. My question is, is there a metric which incorporates TAM, Total Addressable Market, to provide some sense in how far a stock/company could run? This would be especially useful for smaller companies to get a better feel for risk/reward and the potential long-term upside. If there isn't, do you have an equation that would provide some of the same insights? Thanks for all that you do." And he signs it, "A Packers fan in Minnesota."

Oh, boy! That's like being a Yankee fan in the middle of Boston. But great question. And you know, Abi, you and I were chatting this morning, total addressable market is one of those phrases that gets thrown around a lot by analysts and by companies. And I know I've seen situations where a company will come out and say, "Yeah, our total addressable market is ... " and they throw out some enormous number. And I just, sort of, like, do a double take and think, "Wait, is it really?" Like, how should people think about what actually is a total addressable market?

Malin: Yeah. I think it's a great question. And to some degree you are right, sometimes companies will disclose it, but I always try to take those with a grain of salt. And so, unfortunately for this listener, the answer is, generally there is not a metric that you can reliably find across all industries, all companies, you have to do the legwork here. And so, I think this is really where we talk about equity research. And specifically, with valuation, sometimes it's more of an art than a science. And so, this is one of those places where, certainly it's a future, so it's unknown, and there are ways to estimate. And we can be as precise as we want, but you're never going to be fully right.

But generally speaking, the way I tend to think about this is, like I mentioned, companies will usually give you an estimation. So, check the S-1 filing, maybe in their 10-K. A lot of times it's in their investor presentation. You can also look at competitors, sometimes competitors will break it down more clearly. But you're looking for maybe what the company defines as that, right? And then I would compare it to your own, sort of, gut check. So, what I like to do is think about, start by taking the total addressable market and then define it as specifically as possible.

So, a company that I like to do this with, because I -- [laughs] when you talk about companies that file, and your like, what is that figure? Uber filed that their total addressable market was the entire world. I'm not joking, that was literally in the filing. And to me, that's not helpful, right? Because it's too big and it doesn't make any sense. So, you have to think about, you know, if you ran this product, right? So, what they do is provide more or less short-term trips. So, the majority of their trips are three miles or less. And so, if you think about the people who take three mile or less trips, the people who don't have cars, the places within accessibility, within what region or what geographic ranges; you also have to think about who is using this, so at what price point, what socioeconomic status levels you're looking at. So, the more specifically you can define it, the better. And then to get those figures, you want to consult outside sources.

So, make sure that you're double checking, and don't just take populations within metro regions with incomes above X, don't just find it from one source and take that, gut-check that across as many sources as you can find. And so, once you have that total addressable market as a whole, what you want to think about is a reasonable estimate to how much of the market you think one company can grab.

So, 100% is almost assuredly impossible, I can't think of a company that has 100% of any market, economics don't support that. If a market is really big and really profitable, other people are going to flood the market. So, don't ever assume 100%. But the amount that you assume can vary by industry. So, what you're looking at is fragmentation within a market. And so, you want to look at the largest incumbent players to see how fragmented that is.

And so, one that I know off the top of my head, apparel is a highly fragmented market; and that's a surprise to no one. And our largest apparel retailer in the U.S. is Walmart and they have about 7% market share. So, anytime you're looking at the apparel market within the U.S., don't ever assume that someone is going to get more than 7%, because Walmart is so large geographically, their footprint is so big, they are so well-known, etc., etc. So, always scale it appropriately to that.

So, once you figure out how big the market is and what percentage you want them to capture, your third step is to estimate how quickly you believe the company can grow to achieve that level. So, again, you're not ever going to be right, you just want to be reasonable and defensible.

So, again, I mentioned, you know, it's more of an art than a science, [laughs] but that is really the process and how I think about it.

Hill: The only two things I'll add are, you want to be particularly careful when it's, and you referenced [laughs] this Uber, I didn't know that about Uber, that's a gutsy move, [laughs] you know, in your initial filing to just be like, yeah, it's the whole planet; yeah, that's our market. But I think you want to be particularly careful when companies are filing to go public, because they want to make those numbers look as good as possible.

And the other thing is, you know, to Abi's point about checking other sources, this is another situation where I feel like trade media publications can be particularly helpful. So, it's not just, you know, the Bloomberg or The Wall Street Journals of the world, it's the niche media, whether it's apparel, whether its restaurants, retail, whatever, that those can be good sources of information to, sort of, balance off of.

Malin: Definitely.

Hill: I appreciate you being here. Thanks.

Malin: Yeah, thanks for having me, this was fun.

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you do -- based solely on what you hear, or what you do. Really, just do your research. You know what I'm talking about. Ugh! I haven't had enough coffee.

That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.