📝 Building a stock thesis: from idea to decision, with a simple DCF

🎯 In 30 seconds: A stock thesis is a short written argument: why this business is worth more than its price, what has to happen for you to be right, and what would prove you wrong. Writing it down stops you from buying on a tip or a mood. A discounted cash flow (DCF) valuation turns your assumptions about future cash into a value per share today, starting from a safe rate such as the 10-year government bond yield. Treat the answer as a range, buy only with a margin of safety, and decide your selling rules before you buy.

From idea to thesis

Ideas come from everywhere: a product you use, a busy new restaurant chain in your city, a results headline, a friend's WhatsApp forward. An idea is not a reason to buy. "Everyone in my hostel uses this app" is an observation. "This company can grow profits 15% a year for five years because of X, and the price assumes only 8%" is a thesis.

The difference matters because markets are hard. Thousands of investors, including funds with research teams, already have the obvious information. If your thesis is just what everyone knows, it is already in the price. A useful thesis says where you think the market is wrong, and why.

The earlier chapters in this group give you the pieces: the financial statements, valuation ratios, business quality, sectors and cycles, the economy and moats and promoters. This chapter puts them together.

The one-page template

Copy this into a notebook or a spreadsheet, one page per company:

Keep it to one page. If you need five pages to explain why a share should go up, the idea is probably too complicated to act on.

What a DCF does

A DCF estimates what a business is worth today from the cash it will produce in future. Two ideas make it work:

• Free cash flow: cash from operating activities minus capital expenditure. It is what owners and lenders could take out of the business.
• The time value of money. A rupee next year is worth less than a rupee today, because today's rupee could be invested. To convert future cash into today's rupees, you discount it: divide by (1 + r) once for each year of waiting, where r is the discount rate, the yearly return you require.

Choosing the discount rate. Start with a safe rate and add a premium for the risk of owning a business:

• The risk-free rate. In India, the usual choice is the yield on the benchmark 10-year Government of India security (G-sec). Financial Benchmarks India Ltd (FBIL) publishes it every working day, and the RBI's Database on Indian Economy has the history. It changes daily, so look it up and write down the date.
• The equity risk premium. The extra return investors demand for owning shares instead of government bonds. There is no official number; estimates differ by method and by who makes them. Many analysts use a few percentage points.
• A company-specific adjustment. Add more for a business that is small, heavily indebted, cyclical or hard to understand.

In this chapter's example we assume a 7% G-sec yield plus a 5% equity premium, a 12% discount rate. Both are assumptions for teaching, not today's figures. Your DCF must use the current yield and a premium you can defend.

Worked DCF: hypothetical Kaveri Spices Ltd

Kaveri Spices Ltd sells packaged masalas. It produced ₹100 crore of free cash flow last year. Our assumptions, all made up:

• Free cash flow grows 14% a year for five years.
• After year 5 it grows 5% a year forever (the terminal growth rate). This is in rupees, before inflation, so it must be compared with nominal growth of the economy, not real growth. It must stay below the discount rate.
• Discount rate: 12%.
• Net debt (borrowings minus cash): ₹200 crore. Shares outstanding: 10 crore.

Step 1: project and discount five years of free cash flow (₹ crore).

Each present value is free cash flow divided by the discount. Year 3: 148.2 / 1.4049 = 105.5. (The total is 527.4 rather than 527.5 because the spreadsheet carries more decimals than the table shows.)

Step 2: the terminal value. The business does not stop after year 5. The value at year 5 of all the cash after that uses the growing perpetuity formula from The economy and stocks: next year's cash / (discount rate - growth).

Step 3: from business value to value per share.

Notice the uncomfortable fact in that picture. Three-quarters of the value sits in the terminal value, which rests on two guesses: growth forever and the discount rate. That is normal for DCFs, and it is the main reason to treat the output as a range, not a number.

Test the assumptions

Change the two inputs that matter most and recalculate. Value per share for Kaveri Spices:

Inputs that all look reasonable give anything from about ₹152 to ₹276. A DCF that produces one precise number and no range is hiding its uncertainty. Notice too how much the answer moves when the G-sec yield moves: one percentage point on the discount rate shifts the base case by ₹28 to ₹38 a share.

You can also run it backwards. Take today's price and ask what growth would justify it. If Kaveri traded at ₹300, you would need about 25% a year free cash flow growth for five years (with the same 12% discount rate and 5% terminal growth) to reach that value. Ask yourself honestly whether a spice company is likely to do that.

Margin of safety

The margin of safety is the gap between your estimate of value and the price you pay. It protects you against your own mistakes, and you will make some.

Margin of safety = (value - price) / value

At ₹140, even the most pessimistic case in the table (₹152.10) is above the price. That is what a margin of safety looks like: you can be somewhat wrong and still not lose much.

Bigger margins suit businesses that are harder to predict. A steady consumer company with ten years of consistent cash flow might justify a smaller margin. A cyclical, a recently listed company, a small cap with thin trading or anything with governance questions needs a larger one, or a pass.

A DCF suits businesses with positive, fairly predictable cash flow. For banks and NBFCs, where borrowing is the raw material, analysts usually value the business on book value and returns on equity instead. For a company with no profit yet, a DCF is mostly a guess about the distant future, so the range will be very wide.

When to sell

Write your selling rules into the thesis before you buy, when you are calm. Good reasons to sell:

• The thesis is broken. One of your "what would prove me wrong" signs has happened: margins fell for two years running, the promoter pledged more shares, the auditor resigned, a key product lost share. Sell, even at a loss. Do not invent a new reason to hold.
• The price passed your value. If the share rises well above your range, the margin of safety has gone the other way. You can trim or sell, or redo the DCF with honest new information. Do not raise your assumptions only to justify the higher price.
• A clearly better use of the money. Another thesis with a larger margin of safety and similar quality.
• The position grew too large. If one share becomes a big part of your portfolio, trimming controls risk even if the thesis is intact. Position sizing covers this.

Weak reasons to sell: the price fell a bit with the market, a social media post said so, or you are bored. Weak reasons to hold: you do not want to admit a loss, or "it will come back".

Taxes and costs matter in the decision. Selling within a year can mean short-term capital gains tax at a higher rate than long-term gains, and every sale has STT and other charges. Taxes for traders and investors and What trading really costs have the current rules. But do not hold a broken thesis just to save tax. A further 30% fall costs more than the tax difference.

Try it

1. Pick a listed company with positive free cash flow for each of the last five years.
2. From its annual reports, calculate consolidated free cash flow (cash from operating activities minus purchase of property, plant and equipment) for each year, and its average growth rate.
3. Look up today's 10-year G-sec yield on the FBIL website. Write it down with the date. Add an equity premium you can defend and write down why.
4. Build the Kaveri table in a spreadsheet with your company's numbers: five years of growth, a terminal growth rate below the discount rate, net debt from the balance sheet and the share count.
5. Make the sensitivity table: three discount rates by three terminal growth rates.
6. Compare the range with today's share price. Then run it backwards: what growth does today's price imply?
7. Fill in the one-page template, including three specific "what would prove me wrong" signs.

Then check one result from the chapter yourself: with a 13% discount rate and 5% terminal growth, the value per share should come to about ₹168.50.

Sources

• Financial Benchmarks India Ltd (FBIL): benchmark G-sec yields
• RBI: Database on Indian Economy (historical G-sec yields)
• SEBI: LODR Regulations, 2015 (last amended 15 October 2026), regulation 33 on results timelines
• NSE: Corporate filings, financial results