10/30/2023 0 Comments Reverse engineering calculatorNext, we share excerpts from our reports to show exactly how our models give investors important fundamental insight into the future cash flow expectations embedded in stock prices and how much risk they take owning stocks at certain prices. Examples of Insights from Our Reverse DCF Models For more details, see our webinar on How a Reverse Discounted Cash Flow (DCF) Model Works. five years), our models calculate the value attributable to shareholders over 100 forecast periods. Rather than trying to capture all the future growth in cash flows in a static time frame (e.g. NOPAT/WACC not WACC-g) after the forecast horizon. The key to this approach is a terminal value in each forecast horizon that assumes zero growth (e.g. Our models are dynamic, which means we calculate values for the stock based on multiple forecast horizons. Our DCF models do not rely on static forecast horizons such as five or ten years as do traditional DCF models. See the Appendix for details on the specific forecast inputs we use in our DCF models to forecast revenue, ROIC and WACC. Users of our model can choose to solve for any of the four variables by entering forecasts for the other three. In other words, we provide forecasts for three of the four variables in the equation and solve for the 4 th variable. Then, we solve for the Growth Appreciation Period (GAP) needed for the DCF model to produce a stock price equal to the current stock price. Most of the time, we forecast Revenue Growth and ROIC – WACC over a very long forecast horizon, not just five or 10 years (more details below). Sources: New Constructs, LLC and company filings. However, as long as one accepts the premise that the value of an asset equals the present value of future cash flows, then it follows that reverse DCF models can quantify the future cash flows required to justify stock prices.įigure 1: The Basic Valuation Recipe: Same For Stocks And Bonds The only difference is that the future cash flows for bonds are contractually determined while the future cash flows for stocks are undetermined. As shown in Figure 1, the drivers of future cash flow between the two types of securities are analogous. Our DCF starts with the principle that stocks can be valued in the same way as bonds. Better inputs – our DCF models use cleaner data, not analyst earnings or other flawed metrics.įirst Principles: What Is A Reverse DCF Model?.Unbiased by design – our DCF models tell us what the market is predicting.Our DCF model differs from other DCF models in two ways: We will explain further, but you can get numerous real-world examples of how we use our reverse DCF to help investors determine when to buy or sell in all of our Danger Zone and Long Idea reports. The right way to use DCF models is not try to predict the future, but to quantify the future that the stock price is predicting. We won’t argue that, but DCF analysis remains extremely helpful when used to reverse engineer what companies have to do to justify their stock prices, aka expectations investing. We make discounted cash flow (“DCF”) models useful and democratize the benefits of Expectations Investing, which focuses on quantifying the market's expectations for future cash flows that are embedded in stock prices.īad DCF models are misleading.
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