Reverse DCF: What the Price Assumes

EDUCATION, NOT ADVICE · The example company. Example Co. is a made-up company. A model script calculates every figure in this course, so you can check each one. The method works the same way on a real company. Full disclosures →

Run the model backward

Keep every input of the base case except one. Then change that one input until the model gives the price. For Example Co., we change the growth rate in year 1.

At $30 a share, growth must start at 15.0% and fall to 3% by year 10. Last year, growth was 8%. So the price assumes that growth almost doubles first.

Test the claim

Is there a reason for growth to speed up? A new product, a new market or a price rise could do it.
Can the company fund it? At a 24% return on new capital, 15% growth needs reinvestment of 63% of NOPAT.
Has any part of the business grown that fast before?

If the answers are yes, the price can be fair. If they are no, the price assumes too much.

Why this is the better question

A forward DCF can give almost any value, because each input is an estimate. A reverse DCF uses the one figure that is not an estimate, the price. Then the argument is about one assumption.

Our research reports use this method. The Alphabet report asks what margin the price needs, and the Adobe report asks what growth the price needs.

Key points

A reverse DCF finds the assumption that the price implies.
Test that assumption against the record and the plan.
The price is the one input that is not an estimate.

Definitions in the field guide: reverse DCF. Examples: Alphabet and Adobe.