1/ Howard Marks once said that before buying an asset, above anything, he wants to know “the amount of optimism that’s in the price.”
All investors can do this with a handy tool: The Reverse DCF.
I'll also leave a download link to my compact DCF Model at the end of this thread.
2/ We all know a regular DCF. But's what a "Reverse DCF"?
If we consider that a DCF is a Linear Equation, we could say the 'X' (The unknown variable) is the Intrinsic Value.
In a Reverse DCF, we start with the Market Price and try to find some other variable, say Sales Growth.
3/ Let's start by taking an example: VST Industries, a Cigarette-maker based in India.
I valued them on my blog a while ago. I'll be retaining the old assumptions, but using the latest financials.
So please note that the Valuation isn't accurate
4/ This is a "Regular DCF" of VST Industries. The Assumptions I've made indicate an Overvaluation.
The Intrinsic Value is Rs. 3,012, but the Market Price is Rs. 3,492.
Let's not dwell on whether this is correct, since we discussed earlier that this isn't an accurate Valuation.
5/ If we want to do a "Reverse DCF" instead, we need to pick a different variable to 'find'. Say, I will pick the Sales Growth numbers.
I will now remove the Sales Growth numbers from the Model and assume that Sales Growth is the same across the years for ease of calculation.