A normal discounted cash flow (DCF) model asks you to guess the future, then tells you what a company is worth. The trouble is that the answer is mostly your guess handed back to you. Nudge the growth rate by two points and the "fair value" moves by a third.
A reverse DCF runs the same maths the other way. You start from the one number nobody has to guess, the price the market is paying today, and solve for the growth rate that justifies it.
How it works
A company's value is the cash it will produce, discounted back to today. For free cash flow (operating cash flow minus capital spending) growing at g for N years and at g∞ after that, discounted at r:
- each year adds
FCF × (1 + g)^t ÷ (1 + r)^t - after year N, a terminal value of
FCF_N × (1 + g∞) ÷ (r − g∞), also discounted back
A reverse DCF fixes everything except g and searches for the growth that makes the total equal the company's market value.
Reading the answer
- Compare it with the record. If the price needs free cash flow to grow 15% a year and it grew 6% a year over the last decade, the market is betting on a change. That can be right, but now you know what you're agreeing to.
- A low answer is information too. When the price only needs 2% growth, the market expects little. The question becomes whether the business is shrinking.
- Try a range of discount rates. The answer is sensitive to
r. Run it at 8%, 9% and 10% before reading much into one number.
Where it breaks
It needs positive free cash flow, so it says nothing useful about young companies burning cash. One year's cash flow can be unusually high or low, so check the trend. And it treats the whole company as one growth rate; a model built on revenue and margins (like the Modeling tab in Investingly) can show which part of the business has to do the growing.
Try it
Every stock page opens with a reverse DCF on the company's own SEC numbers, and the reverse DCF calculator lets you change every assumption.
For education, not investment advice.