In recent years,
Central Depository Services (India) Limited (CDSL) has emerged as one of the major beneficiaries of the surge in both the stock market and IPO activity in India. As the only listed depository in the country, CDSL has capitalized on the growing number of investors and the increase in trading volumes. This growth has been particularly evident in the company’s financial results, with
CDSL’s profit increasing by 49% in the second quarter of FY25.
Despite the stock's strong performance, the question remains: Should investors still consider buying CDSL shares at this point?
CDSL’s Impressive Growth
CDSL has been making waves in the stock market due to its impressive growth in the number of active demat accounts and its diversified revenue model. The company's active demat accounts surged to 13.73 crore by the end of September 2024, a remarkable 43% increase from the 9.62 crore accounts in September 2023. The rise in demat accounts reflects the increasing retail participation in the stock market, which has been one of the key drivers of CDSL’s performance.
Moreover, CDSL’s second-quarter profit growth of 49% year-on-year was primarily driven by a 55% increase in revenue, thanks to the rising trading volumes in the secondary market and a steady influx of IPOs. The company's diverse revenue mix, with a significant portion coming from annual fixed fees charged to companies for holding securities in electronic form, provides stability to its financials. This makes CDSL less vulnerable to market volatility, as its primary source of income is less affected by daily market fluctuations.
Strong Business Model with Solid Revenue Streams
CDSL’s business model revolves around providing depository services to investors, brokers, and issuers. Companies pay an annual fixed fee to hold their securities in electronic form, which is regulated by the Securities and Exchange Board of India (SEBI). This provides a stable revenue stream for CDSL, even in times of market uncertainty.
Additionally, in a major regulatory move, the Indian government has mandated that all private companies (except small ones) must dematerialize their shares by September 2024. This is expected to boost CDSL’s business further, as more companies move their shareholding records to electronic form. This directive from the government will likely add to CDSL’s market share and drive revenue growth in the coming years.
What’s Driving the Stock's Valuation?
CDSL’s stock has seen an impressive rally, gaining more than 70% in the last year. The company’s current market capitalization stands at ₹33,814 crore, with shares trading at ₹1,618 as of now. Despite the remarkable growth, the stock's price-to-earnings (P/E) ratio of 63.5 suggests that it is currently trading at a premium compared to its historical valuations. While this might indicate that the stock is expensive, it's essential to note that CDSL’s earnings growth trajectory has remained strong, which justifies the higher valuation.
However, considering that the stock is currently trading at 46 times the estimated earnings for FY26, there is little room for a significant re-rating of the stock. This means that while the stock has performed well, future performance will largely depend on the company’s ability to continue delivering strong earnings growth.
Should You Invest in CDSL Shares?
Long-term investors looking for exposure to the growth of India’s stock market and IPO market may find CDSL to be an attractive option, especially considering its stable business model and consistent growth in earnings. The company has a high return on capital employed (ROCE) of 40.2% and return on equity (ROE) of 31.3%, which highlights its efficient use of capital to generate profits.
That said, the valuation of CDSL shares looks expensive, with a P/E ratio of over 63, and the stock is already priced at a significant premium. If you're considering an investment in CDSL, it is important to weigh the potential for future growth against the current high valuation. For those with a long-term investment horizon, CDSL shares may still be an attractive option, particularly if the company can maintain its earnings growth momentum.
Key Factors to Monitor:
Growth in Demat Accounts: The number of new investors in the stock market is growing rapidly. This could continue to benefit CDSL as more individuals open demat accounts for trading and investment.
Revenue from IPOs and Corporate Actions: CDSL’s revenue is closely tied to the volume of IPOs and corporate actions. Any increase in IPO activity will be a positive trigger for the stock.
Government Regulations: The government’s mandate for private companies to dematerialize their shares could provide CDSL with a further growth opportunity.
Valuation: The current high P/E ratio means that future stock performance will be closely linked to the company’s ability to deliver consistent earnings growth. Investors should be cautious about entering at such elevated valuations.
Conclusion
CDSL is undoubtedly a strong performer in India’s financial ecosystem, benefiting from the growing stock market and IPO activities. The company’s stable business model, strong earnings growth, and impressive increase in demat accounts suggest a promising future. However, its current high valuation raises concerns about the potential for future returns in the short term.
For long-term investors, CDSL remains a good investment option, provided the stock’s future growth can justify its premium valuation. However, short-term investors may want to be cautious, as the stock might face some consolidation or price corrections if the growth trajectory slows down or market conditions change.
Ultimately, CDSL’s stock will continue to be a solid bet for those seeking exposure to the Indian equity markets, but it’s essential to carefully consider its valuation and future earnings growth before making an investment.
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