Broking stocks are among the most affected in the recent meltdown on the stock markets, with many shedding a large part of the gains they made in the last two months of 2007 and the first week of January.
For instance, India Infoline Ltd, which had generated 27% returns in one month ending 8 January, when the benchmark equity index Sensex recorded its highest closing of 20,873, has shed 29% since then. Shares of the company closed Rs1,287 on Tuesday. Edelweiss Capital Ltd, which listed at a huge premium of 75% to its issue price of Rs825 in December, has shed 38% in the same period. Two new entrants, Motilal Oswal Financial Services Ltd and Religare Enterprises Ltd have also lost 33% and 21%, respectively, since then.
Analysts say such a sharp correction is due to these stocks’ direct links with the capital market. “The priceearnings (P-E) multiple which the listed broking stocks were commanding before the fall was reflective of the strong bull market and continuation of growth in the retail segment. This isn’t the case now. So, the price-earnings multiples have adjusted to the reality,” said Anil Advani, head of research, Sbicap Securities Ltd. This means there is uncertainty about future income and that is likely to impact earnings and stock prices.
The fall in market prices of brokerages is despite significant growth in the revenues and profit of most brokerage firms in the December quarter.
India Infoline’s income soared from Rs27 crore to Rs239 crore, a growth of 785%, and operating profit rose from Rs22 crore to Rs98 crore, a growth of 367%. Edelweiss Capital’s total income soared from Rs19 crore to Rs46 crore, a 142% growth. Its operating profit, however, fell from Rs9 crore to Rs6.43 crore.
Analysts point out that the past is no guide to the future for such firms. That’s because trading volumes drop sharply in a bear market.
In the cash segment, trading volumes came down from a daily average of Rs19,000 crore in December to a low of Rs11,000 crore as on 28 January. In the derivatives market, the volumes on the National Stock Exchange (NSE) have almost halved, dropping from Rs67,000 crore to Rs43,000 crore in the same period.
In January 2000, Indian stocks peaked. However, they slumped for the following two years. And the average daily trading volumes at NSE came down sharply from Rs5,000 crore in March 2000 to Rs2,300 crore by March 2002. During this period, shares of Kotak Mahindra Finance Ltd which derive substantial revenues from capital market operations, fell by almost 50% from Rs115 to Rs58 each, even as the Sensex fell by just 30%.
Another analyst tracking the broking space, who did not wish to be identified, pointed out the market fall has put a question mark over the visibility of earnings for these firms. In such a situation, there is tendency among investors to prefer other stocks such as banking which are available at the same P-E multiples and have greater visibility in terms of earnings.
However, some fund managers believe that the recent fall in these stocks is not entirely because of fall in earnings expectations.
During the downturn, there is a tendency among fund managers to sell off those stocks first which have shown the maximum rise, said a fund manager who did not wish to be identified.
“We don’t see a huge drop in overall trading volumes. In fact, if the market becomes more volatile, trading revenue of broking companies is bound to increase. But the business model of broking companies is directly linked to the movement of stock prices in general and so their stocks also tend to be high beta stocks” said A. Balasubramanian, chief investment officer of Birla Sun Life Asset Management Co. Ltd. Beta is a measure of the movement of a specific stock compared with that of the market as a whole.
Balasubramanian added that in the next quarter, as the distribution of insurance products will gain momentum, it will boost the overall income of the broking firms, many of which have diversified into this business.