Depository Stocks to Watch Out For 

Heard of the PANDU syndrome?

An article in a leading business daily explained that it is the new acronym for 'pump and dump' stocks.

And that tiny stocks from the semiconductor sector are now the tools for such strategy.

For instance, the stock of RRP Semiconductors has seen a jaw dropping 450x in 18 months. It is trading at a P/E multiple of over 1000x!

But semiconductor stocks are not the only ones basking under the sun.

Stock of a housing finance company with negligible sales growth, no profits and eroding book value would typically be a pariah for long term investors.

But Sammaan Capital (erstwhile Indiabulls Housing Finance) soared over 20% in days after offloading a stake to institutional investors.

The entity's fintech avatar has got investors hooked.

Under the guise of fintech, small finance banks, NBFCs and wealth management stocks have been the darlings of Indian stock markets for a while now.

Some are fetching valuation multiples that put the P/E of market giants, both in the financial and non-financial segments to shame.

So, it is basically the race to 100x P/E or more that is keeping investors keen on such high growth stocks.

Traders and speculators may have been the ones to create the bubble around semiconductor and fintech stocks. But there is no denying that some underlying fundamental factors are likely to keep these sectors in investor radar for a long time to come.

Take financialization of Indian economy for instance.

Government initiatives like the Jan Dhan Yojana and the growth of the UPI digital payment ecosystem have created a fundamental infrastructure for financial inclusion.

The India stack (Jandhan, Aadhaar, mobile) has facilitated creation of scalable financial solutions by providing essential infrastructure for digital payments, identity verification and secure data sharing through its diverse tech stack consisting of account aggregator, Aadhar and allied Aadhar-based solutions, UPI and more.

The India stack is still continuously evolving with new digital rails such as the OCEN (Open Credit Enablement Network) and ONDC (Open Network for Digital Commerce) and can potentially have benefits at a global scale if expanded internationally.

According to a Moody's Investor Service study, the Fintech sector is a leading adopter of artificial intelligence (AI) for risk management and compliance in India.

The stocks of relatively newly listed fintech entities that are leveraging the payments ecosystem have fetched valuations that are at a significant premium in comparison to that of incumbents.

Stocks like Zaggle Prepaid Ocean Services, eMudhra and Network People Services Tech may have distinct business models. However, the underlying premise for their valuations soaring higher is the same. That such services will have deeper penetration in India in few years.

Stocks of New Age Fintech Players Commanding Premium Valuations

Yet another segment of the market that has seen keen investor interest is the stock of depositories.

The growth of depositories is closely linked to the expansion of India's financial markets.

First, they have the untapped potential of leveraging India's 200 m odd demat accounts and benefit from India's rising retail participation in equities. The low penetration (less than 15% Indian households have a demat account, compared to over 60% in the US) leaves a scope to tap nearly 800 m PAN card holders.

Demat accounts are projected to reach 250 to 300 m by FY30. Plus, there is policy push catalyst. Plans like dematerialisation beyond equities to insurance and academic records can open up new revenue streams for depositories.

There are also solid entry barriers to the business. Minimum net worth of Rs 1 bn prevents casual entrants and keeps the system efficient. Plus, a large portion of expenses nearly 60%) is fixed costs for employees, cybersecurity, and IT infrastructure. A new entrant would face significant losses for a prolonged period while it gains market share.

So, depositories function like monopolistic public utilities (power grids, railways). And there is unlikely to be too much competition in the sector. Many countries operate with a single depository, such as the USA (DTCC), UK (Euroclear UK), Japan (JASDEC), and Singapore (CDP).

There is also high switching cost involved. For a broker like Zerodha to switch from CDSL to NSDL, the process of transferring critical data would be operationally disruptive and expensive, making client retention for a new depository extremely difficult.

So, the two depository stocks in India, NSDL and CDSL have sufficient upside in terms of valuations.

CDSL earns around 76% of its revenue from its core, high-margin depository operations, showing a strong focus on its main business.

NSDL, in contrast, earns most of its revenue (around 51%) from payment banking. But this segment is yet to meaningfully contribute to consolidated profits. It is the high-margin depository business, less dominant in overall earnings, that accounts for most of the profits.

Each of these stocks may have a different trajectory of growth going forward.

But it is certainly advisable that investors quit chasing speculative ideas in the fintech space and rather keep the high growth depository stocks in their watchlist.