Why run a DCF backwards
A normal discounted cash flow valuation asks you to forecast growth and tells you what the shares are worth. The weakness is obvious: nobody knows the growth rate, and small changes swing the answer. A reverse DCF keeps the same model but solves the other way. It takes the price as given and asks what growth would make that price fair.
That turns an unanswerable question (“what is it worth?”) into a testable one (“is that growth plausible?”). The approach is sometimes called expectations investing.
find g such that Σ FCF·(1+g)t ÷ (1+r)t + TV ÷ (1+r)N = market cap + net debt
TV = FCFN·(1 + terminal growth) ÷ (r − terminal growth)
A worked example
With the figures loaded above, a company trades at $50 with 100 million shares, a $5,000 million market value. It has $500 million of net debt, so its enterprise value is $5,500 million. Last year it produced $200 million of free cash flow.
- At a 9% discount rate and 2.5% terminal growth, the price implies free cash flow growing about 9.9% a year for ten years.
- That takes free cash flow from $200 million to about $512 million in year ten.
- About 62% of the value sits in the terminal value, the years after year ten.
- With no growth at all, the same model values the shares at about $21.16. The other $28.84 a share is the market paying for growth.
Now the question is concrete: can this business grow its cash flow by roughly 10% a year for a decade? Check that against its history, its market and its margins. If it has grown at 4%, the price is optimistic. If it has grown at 15% with room to run, it may not be.
The inputs that move the answer
- Discount rate. A higher rate needs more growth to justify the same price. The DCF calculator builds one from WACC if you want to derive it rather than choose it.
- Terminal growth should stay at or below long-run nominal GDP growth, typically 2–3%. Raise it and the implied near-term growth falls, because more value is assumed to arrive later.
- Starting cash flow. A single unusual year distorts everything. Use a normalised figure where capital spending or working capital was out of line.
- Net debt. Leases, pensions and other debt-like items belong here for a fair comparison.
Where it stops working
A reverse DCF only works for businesses with positive, reasonably stable free cash flow. For a company that burns cash today, a single growth rate is meaningless, and banks and insurers are valued on different measures entirely. And the answer is only ever as good as the discount rate: it describes what the price implies under your assumptions, nothing more. The multi-agent research guide covers how to stress-test the growth story itself.