You will be able to work out the growth or margin that the current share price implies.
Open the DCF model for the company you are studying and write today's share price beside the value per share your model gives. When the two differ, it is easy to decide the market has made a mistake. A more useful question is what assumptions the current price already contains, and whether you believe them. A reverse DCF answers that. It is the same DCF model run backwards: you set value per share equal to today's price, then solve for the one input that makes this true. That input is usually revenue growth or margin. Every other input stays at your base case.
Marcus is analysing Larkspur, a cyclical supplier to the chip equipment industry. All the figures in his case are invented, and company figures are in S$ millions unless stated. His DCF values Larkspur at about S$1.80 a share against a share price of S$1.60, which tempts him to conclude that the market is wrong by 12%. Before acting on that, he runs a reverse DCF at S$1.60.
He begins with the share price and the number of shares. Larkspur has 300 million shares outstanding, so equity value is S$1.60 x 300 million = 480. In the model's units that is 1.60 x 300 = 480. Adding net debt of 20 gives the implied enterprise value, which is market equity value plus net debt: 480 + 20 = 500. His own base case gives an enterprise value of about 558.6, so the market is pricing the business below his view of it.
To keep the answer to a single number, go to the Inputs tab of your DCF model and replace the five yearly growth rates with one rate applied to every forecast year. Leave everything else at base case: operating margin, capex and working capital ratios, discount rate and long-term growth. For Marcus, that means an operating margin of 13.5%, a discount rate of 9% and long-term growth of 2%, over a forecast period of five years.
You don't need trial and error to find the answer. Goal Seek is a spreadsheet tool that changes one input cell until a target cell reaches a value you choose. In Excel it sits under What-If Analysis. In Google Sheets, the Goal Seek add-on does the same job. Set the cell to your value per share cell, set the value to the current price, and set the cell to change as the single growth rate cell. The tool tries values until the result matches. Copy the result somewhere safe before you change anything else, because the next run overwrites it.
For Larkspur at S$1.60, Goal Seek returns about 1% a year for five years at a steady 13.5% margin, then 2% a year forever. Marcus's own base growth path is 8% fading to 3%.
You can also solve for inputs other than growth. Marcus restores his base growth path and solves for operating margin instead. The price then implies a margin of about 12.5% every year, against his 13.5%, or about one percentage point lower. The same price can be read in more than one way: as slower growth, or as lower margins.
Next, put the implied figure beside the company's actual record. Larkspur's revenue grew from 300 in FY1 to 400 in FY5, about 7.5% a year compounded, and that period included one downturn. Its average operating margin was about 13.4%. The price assumes less than the company has already achieved.
Larkspur's result is the opposite of what the exercise usually shows. Reverse DCFs on fashionable stocks often show prices that need growth of 20% or more for a decade, far above anything those companies have achieved. Where implied growth is far above history, the price assumes a great deal and any disappointment hurts. Where implied growth is below history, the price assumes little, and the question becomes why the market is so cautious.
There are always candidate reasons for that caution, and you should name them. Marcus takes two from the reading log he built in Lesson 6.8, Build an annual report reading log for one company:
an expected downturn in chip equipment spending, which would hit a cyclical supplier hard the risk that one of Larkspur's two largest customers, which together make up 62% of revenue, moves part of its orders to a second supplier it is qualifying
Marcus began with a vague view: "Larkspur looks cheap." The reverse DCF lets him replace it with a specific statement in three parts: what the price assumes, what he expects and why, and what would prove him wrong. The price assumes about 1% growth a year. He expects more, because customer guidance points to growth and the company's history is about 7.5%. He is wrong if a big customer moves meaningful volume to its second supplier, or if the next downturn arrives within two years.
The statement tells him what to look for in the next results announcement and the next customer guidance. Because he has written down what would make the market right, he is less likely to hold on out of pride if the story changes.
A reverse DCF is not a buy signal, and it does not tell Marcus to buy. A price that assumes little can still be too high if the cautious case comes true. Before deciding anything, use scenarios to see the range of outcomes, as set out in Lesson 8.6, Sensitivity tables and scenarios instead of one target price.
For the activity, run a reverse DCF on your company at today's share price, solve for the revenue growth it implies, and write that figure next to the company's actual growth over the past five years.
Run a reverse DCF at today's share price. Write the revenue growth it implies beside the company's growth over the past five years.
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