How to Analyse Capital Markets Companies and Identify Investment Opportunities

Umesh Tripathi:
Hello everyone, I am Umesh Tripathi and we are learning the concepts of fundamental analysis. In this chapter, we will focus on how to analyse investable companies in the capital markets sector. We will understand what the capital markets space is, who the key players are, how their business models work, and which ratios matter when you are taking an investment decision.

What Is the Capital Markets Sector?

The capital markets sector consists of companies that facilitate the buying and selling of financial securities such as shares, bonds and other investment instruments. These are not usually the businesses whose shares you buy. Instead, they are the platforms and service providers that make investing possible for everyone.

Capital markets broadly include:

• Stock exchanges such as NSE (National Stock Exchange) and BSE (Bombay Stock Exchange)
• Brokers and online trading platforms
• Asset Management Companies (AMCs) that run mutual funds
• Depositories that hold securities in electronic form
• Registrars and transfer agents (RTAs) and some investment banks

These entities help investors place orders, settle trades, hold securities safely and manage their portfolios.

Primary Market and Secondary Market

The capital market is divided into two main segments.

1. Primary Market

The primary market is where a company raises money from the public for the first time.
This happens through the Initial Public Offering (IPO) process, where existing shareholders and the company offer shares to the public. New securities are issued here and investors subscribe to them.

2. Secondary Market

Once the shares are listed on an exchange, they start trading in the secondary market.
Here, investors buy and sell shares with each other on platforms such as NSE and BSE. No new shares are created in this market. It is simply a marketplace that provides liquidity to investors.

Key Participants in the Capital Markets Sector

The important participants are:

• Stock Exchanges: NSE and BSE provide the trading platform for shares, bonds and derivatives.
• Depositories: NSDL and CDSL are the two main depositories in India. They keep records of investors’ holdings in demat form and handle settlement of securities. Both are listed companies themselves.
• Asset Management Companies (AMCs):
  • Examples: HDFC AMC, Nippon Life India Asset Management.
  • They manage mutual fund schemes and earn fees on Assets Under Management (AUM).
• Registrars and Transfer Agents (RTAs):
  • Example: CAMS.
  • They keep records for mutual fund investors and provide back-office services.
• Brokers and Investment Platforms:
  • Example: mStock, which offers retail and institutional trading facilities as a low-cost discount broker.

Whenever you buy shares or mutual funds, your holdings are stored in your demat account, but the depository is the entity that maintains the master records in digital form.

Understanding Business Models

To analyse a capital markets company, you must first understand how it makes money. Some typical revenue sources are:

• Brokerage income on trades placed by customers
• Platform or subscription fees on advanced products and tools
• Fees from exchanges or incentives based on trading volumes
• Technology and algorithmic trading solutions provided to clients
• Management fees on AUM in the case of AMCs
• Service fees for record-keeping and processing in the case of RTAs and depositories

For example, a broker that allows customers to trade on exchanges might charge a small brokerage fee per order. If the broker sees rising customer additions and higher trading volumes, revenue and profitability can grow even if the per-trade fee is low.

In AMCs, the key question is whether AUM is growing consistently and whether the company can maintain healthy margins while scaling.

Important Ratios for Capital Markets Companies

Once the business model is clear, the next step is to look at financial ratios.

1. Return on Equity (ROE) and Return on Capital Employed (ROCE)

Capital market businesses are often asset-light, so strong companies usually show high ROE and ROCE.

• Example: Some leading players such as CDSL report ROE and ROCE in the range of 40–45 percent, which indicates efficient use of capital.

2. Net Profit Margin (NPM)

This ratio shows how much profit the company retains from each unit of revenue.

• Depositories and some platform businesses often have very high net profit margins.
• Example: CDSL’s net profit margin is around 60 percent, reflecting a highly profitable model.

3. Asset Turnover Ratio

This is especially relevant for exchanges. It measures how efficiently the company uses its assets to generate revenue. Higher turnover means better utilisation.

4. Assets Under Management (AUM) for AMCs

For asset management companies, AUM size and growth are critical.

• Example: HDFC AMC had AUM of about ₹5.5 lakh crore in FY24. A rising AUM with stable or improving margins usually points to a strong franchise.

5. Operating Margin

Operating margin reflects the efficiency of core operations.
Top AMCs and service providers often have operating margins above 70 percent, which shows strong cost control and pricing power.

6. Market Share

Market share indicates the competitive strength of the company.

• Example: CDSL has a dominant share in depository services.
• CAMS reportedly handles over 69 percent of mutual fund portfolios, which gives it a near-monopoly position in that niche.

7. Revenue and Transaction Volumes

For brokers and depositories, it is important to track whether trading volumes and transaction counts are rising, because their income is directly linked to activity on the exchanges.

8. Client Addition and Retention

Client metrics show the growth potential and stickiness of the franchise.

• Example: mStock aims to add around 10 lakh users to its primary brokerage plan over the next two years.
  Steady client addition with high retention is a positive indicator for long-term growth.

Moats and Competitive Advantage

When evaluating capital markets businesses, you should look for a moat, which is a sustainable competitive advantage.

A company has a moat if most customers prefer its services over competitors, even when multiple options exist.

For instance, if there are many pizza outlets in an area but most customers repeatedly order from a single brand, that brand enjoys a moat in that locality.

Similarly, in capital markets:

• CDSL enjoys a strong position in depository services.
• CAMS dominates mutual fund record-keeping.

Such companies benefit from scale, network effects and high switching costs, which protect their profitability.

Regulatory Environment

The capital markets sector is heavily regulated by SEBI (Securities and Exchange Board of India).

SEBI’s rules on pricing, disclosure, product structure and investor protection can directly affect the charges and revenue of capital market companies. Regulatory changes may:

• Cap certain fees
• Tighten compliance requirements
• Alter the way products can be sold

This means investors must always keep an eye on the regulatory environment while analysing companies in this sector.

Key Risks in the Capital Markets Sector

Some of the major risks are:

1. Market Volatility
   Revenues can be cyclical. If markets turn very volatile or remain subdued, trading volumes may fall, which hits brokers, exchanges and depositories.
2. Regulatory Changes
   Sudden changes in SEBI rules can impact business models and profitability.
3. Margin Pressure
   Low-cost and zero-brokerage players create pricing pressure, which can reduce margins for traditional brokers.
4. Technology Risk
   The sector is highly technology driven. A new entrant with superior technology or user experience can disrupt existing players. Companies need to keep investing in platforms, cyber security and innovation.

Summary and Takeaways

To analyse capital markets companies effectively, focus on:

• Their business model and core revenue drivers
• Market share and competitive advantage
• Profitability metrics such as ROE, ROCE, net profit margin and operating margin
• Scale indicators such as AUM, transaction volumes and client base
• Moats in the form of dominant position or near-monopoly in a niche
• Regulatory environment, including SEBI guidelines and any upcoming changes
• The scalability of the business as India’s investor base continues to grow

Strong capital markets companies typically show consistent growth, high profitability, robust governance and a clear competitive edge.

Disclaimer:
Investments in securities markets are subject to market risks. Read all related documents carefully before investing.