The rise in the average volumes at stock exchanges is a signal that financial service providers would see a rise in their toplines.
Peter Lynch had a thesis that trends were usually visible and often actionable, several quarters before the financials triggered buy signals. The popularity of a new clothing line, or a new perfume for instance, may be evident long before it is confirmed by quarterly statements.
Lynch also remarked on a blind spot – the reluctance on the part of financial analysts to make calls on the financial services industry. As he put it, there were times when his mutual fund should have been buying other mutual funds!
The gap in the coverage of financial service providers (FSP) by FSPs is not odd because it stems from the need to avoid conflicts of interest and also, it seems a little strange for an FSP to be recommending investments in competitors.
Right now, FSPs may be in the early stages of a cyclical turnaround. Apart from the reluctance of FSPs to make calls on other FSPs, the uptick is being masked by a base effect that under-estimates the strength of the trend reversal. The industry's fortunes, particularly the performance of securities trading outfits, is linked to the stock market. If we compare Q1,2008-09 with Q1, 2009-10 (year-on-year), the numbers are uninspiring. Although the bull market had peaked by April-June 2008, the crash occurred between October 2008-March 2009. YoY revenue volumes for Q1, 2009-10 are flat and so are net and operating profits.
But sequential comparison makes it obvious that there has been a strong trend reversal. Quarter-on-quarter, all the comparisons look good for April-June 2009 compared to Jan-March 2009. This is not going to be a linear relationship. But if the turnaround is sustained, FSP could deliver FY 2009-10 EPS growth in the 70-80 per cent range. That would justify the current high valuations.
More From This Section
There are several listed players in the financial services provider (FSP) space (even if we exclude commercial banking) as well as unlisted securities-trading subsidiaries of banks, etc. FSPs are hyper-sensitive to changes in the financial cycle. They can be both great trades as well as great investments if you decode the financial cycle. Most brokerages position themselves as brands and of course, quality of service, trust, and so on, are key factors. However, a cynic would consider FS a commodity or suggest that there isn't much difference between competing FSP brands. Competition ensures that margins are low and there isn't too much difference in product-features and quality of service.
By and large, brokerages offer similar plans and similar “strike rates” in terms of recommendations. User-charges and margin deposits fall within a narrow range. The size of the physical footprint can be a factor and so is the smoothness of user-interface for e-traders. Also of course, coverage across instruments and exchanges is key.
Variations in FSP toplines appear extraordinary until you relate it to the difference in trading volumes that occurs during market cycles. In 2007-08, during a bull-run, the NSE traded an average Rs 67,000 crore per day (Equity+F&O). In 2008-09, during the bear market, it dropped to an average of Rs 58,000 crore. The fall was more marked in the second half of FY 2008-09 and volumes declined QoQ through the last three quarters.
In June 2009, NSE's volumes hit Rs 95,000 crore, and Q1, 2009-10 grew 25 per cent sequentially, compared to Q4, 2008-09. The bounce is a result of higher volume as well as higher values. The picture was similar on the BSE (which has roughly 25 per cent as much volume as NSE).
In the commodity markets, despite a more mixed picture in terms of rising values, there was a 20-25 per cent rise in turnover as well. Most of this growth came in the MCX, which has 90 per cent marketshare. The removal of CTT should further help growth.
If trading volumes are higher, the brokerage industry should see roughly commensurate growth in toplines across the board. Obviously some brokerages may grab larger marketshare during this expansionary phase. Different operations have different customer profiles and different cost structures. But the broad equation should remain true.
One classic sign of cyclical behaviour is a situation where price-earnings ratios drop even though prices rise. This occurs only where the cyclical character is so pronounced that earnings growth outpaces the rise in shareprice. This could happen in FSP.