What is a reverse DCF?
A reverse DCF runs a discounted cash flow model backwards. Instead of forecasting growth to find a value, it takes the market price as given and solves for the growth rate, or the annual return, that the price implies. It turns a price into an expectation you can test.
“A stock with $5.00 of free cash flow per share trades at $150. If I want 9% a year, what growth is the price assuming?”
Free cash flow growth of 11.01% a year for ten years, then 2.5% forever. That is the bar the business has to clear for $150 to be fair. Try this scenario
“What if the price runs up to $200?”
The implied growth climbs to 14.82% a year. A 33% higher price asks for nearly 4 points more growth every year for a decade. Try this scenario
How do you read the implied growth rate?
Compare it with what the business has actually done. If free cash flow grew 6% a year over the past decade and the price implies 15%, the market expects a sharp acceleration. If the implied rate is below the company’s record, the price may be leaving you a margin of safety.
Two refinements under More options make the test fairer. Fading growth lets growth slow toward a lower rate by the last growth year, as most companies do. Net cash per share takes the cash or debt out of the price, so you solve only for what the market pays for the business itself.
“Same $150 price, but the company holds $20 a share of net cash?”
The implied growth falls to 9.12% a year, because $20 of the price is cash, not future growth. Try this scenario
“And if I expect growth to fade to 4% by year 10?”
Then $150 needs growth to start at 17.06% a year and slow from there. Slower later years must be made up early. Try this scenario
What return does the current price offer?
Switch to Solve Implied Required Return and enter your own growth forecast. The answer is the annual return you would earn by paying today’s price if that forecast comes true. Compare it with the 8–10% investors commonly ask of stocks: below that, the price is rich for your forecast.
“If cash flow grows 10% a year for ten years, what return do I get paying $120?”
About 9.91% a year. At $150 it would be 8.57%: the more you pay for the same cash, the less you earn. Try this scenario
Prefer to start from your own forecast? The DCF intrinsic value calculator works forward to a value per share, with your margin of safety and buy-below price.
Reverse DCF FAQ
What does a reverse DCF tell you?
It tells you what has to happen for today’s price to make sense. Instead of forecasting cash flows and arriving at a value, you accept the price and solve for the growth or return it assumes. Then you judge whether the business can plausibly deliver it.
What is a reasonable implied growth rate?
Compare it with the company’s own record and its industry. Free cash flow growth well above 15% a year for a decade is rare, and few large companies sustain it. If the implied rate is higher than anything the business has achieved, the price leaves little room for error.
Should I solve for implied growth or implied return?
Solve for growth when you have a required return in mind and want to know what the market expects. Solve for return when you trust a growth forecast and want to know what paying today’s price would earn you. Both use the same equation from opposite ends.