Reverse valuation: what the share price already expects
Traditional valuation asks “what is this company worth?” and depends on growth forecasts that are easy to get wrong. Reverse valuation, popularized by Michael Mauboussin and Alfred Rappaport in Expectations Investing, asks the opposite: given today’s price, what growth is the market already assuming? Then you judge whether that expectation is realistic.
How it works
- Enterprise value: share price × shares + net debt. In the example, $60 × 800 million + 4,000 million = 52,000 million.
- Discounted cash flow: free cash flow grows at a rate g for a number of years and then at a modest rate forever; everything is discounted at the rate you require.
- Solve for g: the calculator searches for the growth rate that makes the discounted cash flow equal to the enterprise value.
Reading the answer
| Implied vs. historical growth | What it suggests |
|---|---|
| Well above (more than 3 points) | Demanding expectations: the company has to accelerate, and any disappointment can hurt the price. |
| Close (within 3 points) | The price looks fair if the company keeps its past pace. |
| Well below | Modest expectations: repeating the past would make the stock cheap. |
In the example, at a 9% discount rate the price implies 7.9% a year of cash-flow growth for 10 years, against 6% historically: slightly demanding, but in line.
What you need
- Free cash flow to the firm (operating cash flow minus capex), ideally averaged over a few years.
- Net debt (debt minus cash), from the balance sheet.
- A discount rate you consider fair for the risk, and the historical growth of cash flow.
Reverse valuation does not say whether a stock will go up. It turns the price into a concrete, testable claim about the future, which you can compare with the company’s market, competitors and track record.