process
Reverse The DCF
The rule
Do not forecast future cash to guess a price. Start from today's price and work out what growth the price is already assuming.
Where it flips
Reading the price's built-in hopes can trick you into thinking the market's number is a fact. It is still just one more model, with its own guesses about discount rate and time. The fix is to test how much the built-in growth shifts when the cost of money changes a little.
Most people build a cash-forecast model forwards, plug in growth guesses, and get a 'fair value' that mostly just repeats their own guesses. Turn it around. Take the current market price as given. Work out what sales growth, margin and reinvestment the market must be assuming to justify that price. Now you have something honest to react to. It is a clear statement of what the crowd believes. Your only job is to decide whether that belief is too hopeful or too gloomy.
A worked example
A stock trades at ₹1,200. Rohan works the model backwards and finds the price only makes sense if sales grow 25% a year for ten years. He judges that unlikely for a mature lender. [illustrative]
How to spot it
- ·starting from the price, not from a target
- ·asking 'what must be true', not 'what will happen'
- ·a built-in growth rate that sounds absurd, or absurdly cheap
Michael Mauboussin & Alfred Rappaport · Expectations Investing