A traditional DCF starts with forecasts and works forward to a value. Expectations investing, developed by Michael Mauboussin and Alfred Rappaport, turns this around: it starts with the current price and asks what future performance that price already assumes. This approach is often called a reverse DCF.
In this conversation on The Investor's Podcast, Mauboussin explains the three-step process:
- Read the expectations built into the price using value drivers such as sales growth, margins and investment needs
- Test whether those expectations are too high or too low using strategic analysis, scenario analysis and historical base rates
- Compare the resulting expected value with the price to decide whether it is justified
A powerful way to sense-check any valuation or offer price: before arguing about the number, ask what you would have to believe for it to be right.