Reverse discounted cash flow

Running a discounted cash flow backwards: instead of computing a value, solve for the growth rate and discount rate that would justify the price being asked.

Example

A comparables median implying an enterprise value near 20,500,000 corresponds to roughly a 9% discount rate with 3.5% perpetual growth.

Important

It converts a vague disagreement about value into a specific claim about two numbers, which can be accepted or rejected. That is usually more useful than the forward calculation.

Related terms

• Discounted cash flow — Valuing an asset as the money it will produce, with each future amount reduced to reflect that money arriving later is worth less than money arriving now.
• Terminal growth rate — The rate at which cash flow is assumed to grow forever after the explicit forecast ends. Sits in the denominator of the terminal value formula alongside the discount rate.
• Discount rate — The annual rate at which future money is reduced to a present value, reflecting both the time you wait and the risk that the money does not arrive.

Lessons that explain it

• What each method is for, and what to do when they disagree — Three methods on one asset produce three different answers, and the disagreement is the most useful output. Averaging it away destroys the only thing the exercise produced. (10 min)
• Work backwards: what would have to be true to justify this price? — Rather than producing your own valuation and comparing it with the price, take the price as given and solve for the growth or margins it assumes. Then judge whether those assumptions are plausible. (11 min)

All 578 terms in the Investing glossary