Broking stocks are staring at a bleak future, with a decline in revenues on account of a shift in volumes from cash to derivatives and poor penetration in retail stock investing

Experts have forecast a good year for the stock market. But even as the Sensex climbs to new highs, the picture doesn't look so bright for shareholders of brokerages firms which operate at the heart of the stock market, according to analysts tracking these companies.

Consider this: Since 1 January 2008 up to 5 January 2011, the stocks of major brokerages have fallen by more than 50%. Motilal Oswal Financial Services is down by 55%, Edelweiss Capital is trading down by 72% and India Infoline has plummeted a whopping 79%. Similarly, Indiabulls Financial Services has tanked by 77% and Geojit BNP has fallen by 62% in the period. It is interesting to note that during the three-year period, the BSE benchmark index-the Sensex-has remained flat.

All leading brokerage firms have been performing poorly over the last three years, even as the market is headed higher. The recent quarterly results of these firms show no signs of revival. The total revenue of Motilal Oswal Financial Services in the September 2010 quarter stood at Rs8.95 crores, a sharp decline of 61% over the previous corresponding quarter. India Infoline, which is not as dependent on broking income, still saw September quarter revenues decline by 6% compared to the year-ago quarter.

The main reason for decline in revenues of brokerage firms has been the change in revenue mix and poor penetration of retail stock investing. Despite powerful economic growth and a rising stock market, the retail investor community has not been enthusiastic about stock investing. This is partly due to the inadequate developmental role of the regulator and stock exchanges and too many cases of malfeasance by the broking community.

Moneylife has written a series of stories on the diminishing investor population, with analysis and commentary on various issues such as price manipulation, the role of market regulators, and so on. The reports pointed to the comments by union minister of state for finance, Namo Narain Meena, in response to a question in Parliament, that the Indian capital market is narrow, shallow, illiquid and concentrated in the hands of a few individuals located at a few centres. (Read, 'Different Strokes: Where are the investors?')

Sardar Sukh Dev Singh Dhindsa, member of parliament, had raised a question in parliament about the number of client identities and PAN identities that traded actively in the market on the National Stock Exchange (NSE), in April-June 2010, and accounted for 50%, 60%, 70%, 80% and 90% of the total trading turnover on average, on a daily basis, in the cash equity market and in the F&O (futures & options) segments. The minister said in his reply that 30.90 lakh investors traded on the NSE's cash market in the three months, but 90% of the investment came from only 1.92 lakh investors-in other words, trading volumes of the bulk of investors are trivial and irrelevant. The number drops to a fourth (41,654) when you consider 80% of the turnover. And, finally, 50% of the turnover came from a shockingly low 451 investors, of which 156 were proprietary traders. He further stated that 106 participants account for half the derivatives market turnover. The minister's comment suggests that the market being very narrow, tracking price manipulation should be easy.

Poor market penetration has combined with the change in market structure itself. Even those who are trading regularly have taken to options, which results in low revenues for brokerage firms.

According to Aditi Thapliyal, analyst - banking and financial services, Execution Noble, "The main reason for the fall in broking stocks is muted growth in the cash segment of the market, with a majority of the volumes coming from the futures and options segment, which is a very low margin business."

This was echoed by Apurva Shah, head of research at Prabhudhas Lilladher, "There are multiple factors for the poor performance of these stocks. The major one is volumes, which are growing, but the commission pool remains very low. Also, there is not much margin from options trading."

Another analyst feels that the low retail participation is also a reason for the low performance of these stocks. "There is very low retail participation, which has taken toll of the stocks of brokerage firms. Currently, there is more participation by foreign investors. Equity investment, which is the main driver for these stocks, is largely under-penetrated in India. May be after a quarter, we would see some improvement," said the vice-president of research at a leading brokerage firm, who requested not to be named.

According to Mr Shah, "It is tough to say if these stocks will perform anytime soon as the cash segment remains mired in low volumes. In the near future there won't be any change. Long term we can see some change as valuations may come down."

Within this segment, there would be some stocks which would do better than the others. "Our top pick among broking stocks is Edelweiss. We expect the stock to outperform its broking peers given that its financing segment in particular is showing a great deal of traction. For India Infoline, the stock is yet to recover from the reputational damage to its franchise from its involvement in the Money Matters QIP," Ms Thapliyal said.— Alekh Angre