Reading Financial Statements of Capital Market Infrastructure Firms

Numbers tell the story of a business more honestly than any headline, but only if you know how to read them. Many first-time investors who check the NSDL Share Price rarely open the accompanying annual report. The same is true for those who glance at the CDSL Share Price without exploring the profit and loss account. This guide explains how to approach the financial statements of capital market infrastructure firms in a practical way.

The Profit and Loss Account

Start with the total income, breaking it down into its constituents. Revenue from issuer charges, transaction fees, annual maintenance-related income and other operating services. Do note the amount of income that comes from other sources like interest and investment gains, as this tends to be a volatile number.

Go to the expenses section and check out the technology- and employee-related costs, compliance spend, etc. Are these growing faster than revenues? If not, operating margins should give a good indication of operating leverage.

Operating profit margin

This is basically the ratio of operating revenue to costs. Market infrastructure companies tend to have good margins due to their scale advantages.

Check if the margins are stable across reporting periods. A sharp dip may indicate a big investment, one-time expenses or a price war. Read up on the management comments and disclosures to understand the context. A rising trend is always a good sign.

The balance sheet

Net worth and reserves will show the amount of capital that has been accumulated over the years. The third item to look at is the list of investments. What quantum is parked in different kinds of investments (bank deposits vs government securities vs mutual funds etc.) and the risk associated with them?

Debt is not really a big concern for these kinds of businesses. Cross-verify with the borrowings section and check out contingent liabilities as well.

Profit is an accounting fiction. Cash is the realisation of profit. So look at cash flow from operations and see how it compares to the profit number. If cash flow from operations is consistently lower than the profit number, find out why. Check out the capital expenditures or spending on technology and infrastructure and compare it to the amount of dividends paid out. A company that generates plenty of free cash after reinvestment and dividends is a healthy company. It is important to look at the numbers beyond the headline profit number. A company that has positive cash flows from operations and invests in technology to grow will be more valuable than one that is stable but has poor margins.

Important ratios to watch out for:

Return on equity shows how much profit has been generated from shareholders’ funds. Dividend payout ratio helps to understand what proportion of earnings are being paid out as dividends. Earnings per share and its growth trajectory indicate the amount of profit that accrues to each shareholder. Book value per share is another important metric.

It is important not to look at ratios in isolation. Context is crucial. A high return on equity may be countered by a low operating margin if the company is not able to sustain its costs. Another pointer would be the movement in other income and operating profit. If other income is rising while operating profit is falling, it could indicate some underlying issues. All financial statement footnotes need to be studied closely, especially auditors’ reports if there are any.

How to build a good financial analysis habit

Build a one pager for each company that you follow, noting down the revenue breakup, margins, cash flow, dividend and major news. Keep updating it based on the latest numbers released. It will help you keep track of the changes without getting overwhelmed. And don’t forget to do a deep-dive study on the stock occasionally to keep a check on your assumptions. There isn’t a rule about analysing financials only after the initial purchase. In fact, as an investor, it makes far more sense to study a stock’s fundamentals before buying it and then monitoring it at periodic intervals instead of checking it after every small fluctuation in its share price.