Dear @maverickroger,
Thanks for raising these queries. I will try to answer to the best of my knowledge. Please note that, I am a person of Computer Science background, who never learned finance/ commerce/ economics, hence you might find a few anomalies in my responses below. Please do not hesitate to point out any mistakes, so that I get a chance to improve further.
Sorry for the long reply, but I wanted to make my whole thought process very clear. In the below response, I am trying to address all your queries, but may not be strictly in the same order.
I agree with your opinion that, Arihant is an “unnoticed gem”. In fact, after doing my initial due diligence of this stock during May-17 (I just accidently stumbled upon it, as I was comparing the micro/ small caps on the NBFC sector on MarketsMojo), I got really dumbfounded looking at its quality versus undervaluation. My first impression indeed was that, finally I have found out a real “hidden gem” in its true sense!
However, I was still doubtful, why the stock price was not moving up, hence I had posted a message on this forum during June-17, as you would have already noticed. However, my above message failed to get the attention of most of the ValuePickr members then, as it was a microcap with market cap of just about 100 crores and never recommended by any analysts/ brokerage houses. I think, brokerage houses do not ever recommend the stocks of other brokerage houses 
.
Well, I should also thank ValuePickr and the boarder @AlokBhola, who really convinced me with his earlier messages on this forum that, this stock indeed is a cyclical one (my earlier imagination was that, only stocks like sugar were cyclical ) and as cycle turns positive and stay there for a prolonged duration, we should see a huge upside in these stocks. I looked at the chart of Emkay Global during May-17 and realized that, Alok’s reasoning was spot on! Thanks Alok.
Arihant’s FY17 net profit was 37% higher than Emkay’s, but its current Market cap is just 330 Crores, as against Emkay’s 757 Crores. Emkay had an early runup in its stock price as compared to Arihant, may be because it is listed on NSE and also got the attention of marquee investors like Dolly Khanna and Porinju.
However, till one month back, I was still doubtful if India had really entered a strong bull market. However, by now I have started believing that, we are already in a raging bull market. One reason for the above belief is that, my core portfolio (mostly micro, small and midcaps) which includes stocks like Arihant Capital, Shankara, Emkay, BEPL, Phillips Carbon, Himadri, Edelweiss, Manappuram, Capital First, DHFL and PNB Housing collectively increased by more than 40% in just the past 30 days, in spite of the ongoing North Korea tension and the earlier China tension.
Also, my belief about sustainability of this ongoing bull market is strengthening day by day. I will explain the reasons below.
Ever since I spotted Arihant and initially purchased it in May-17 for Rs. 57, I have been tracking it very closely. I kept on getting all the right “vibes” from this company time and again. I could sense that, it is a business house with the perfect balance of aggression and conservatism. If you browse through its history, it has never negatively surprised its investors, even during the toughest of market conditions, while most of its bigger peers ran into heavy losses. It has been a regular dividend payer. Its operating margins and ROCE had been consistently higher compared to all its notable peers.
Now, I don’t know if this would be against value investing principles, but my belief is that, as stock investors, we should leave certain stuff to perception and sixth sense also. I constantly tried to gather and verify a lot of details about this company using my tool and guru “google search”. I currently have the perception that, this company has the right ambitions, discipline, potential and the right governance to become a large cap like Edelweiss one day. I am again disclosing that, this is just my intuition for the time being. If I am not supposed to write this way on this forum, please caution me and I will delete this paragraph.
I formed the above intuition for various reasons – looking at the consistency in its cash flows, dividend payment, timely filing of disclosures, performance during toughest of the times, ability to protect and constantly improve its margins etc. Even seemingly cosmetic things like presentation and user-friendliness of its website and availability of useful information over there, how they keep the information at their website upto date speak a lot about their quality consciousness and customer-orientation. The quantity and clarity of information shared in their Annual Reports and Quarterly results (best-in-class for a microcap) talks a lot about their Corporate Governance.
During my study, I came upon a site (I do not recollect the website now) which compared all the major stock brokers in India on number of customer complaints and Arihant had the least number of customer complaints per customer and it was significantly ahead of others on that statistic too. I have been regularly monitoring the naukri.com site and their company website on the way they come up with job advertisements, and constantly filling up those positions in a disciplined way.
I have formed a belief that, they are a very tech-savvy company, which will help them in efficiently running all their business operations and also help their online trading business a lot.
A simple Google search will reveal the fact that, they are also making their Research activities stronger and stronger day by day. This will in turn help them to differentiate from their competitors.
If you carefully analyse the data provided at a brokerage-comparison web site (Stock Broker Comparisons in India 2020 | Brokerage, Video Reviews), Arihant had far more competent brokerage rates compared to almost all other full-service stock brokers and Arihant’s rates were even comparable to discount brokers like Zerodha. In spite of the above, Arihant has one of the highest operating margins in the industry.
Arihant had 690 investment centers (overall 1.30+ lacs of customers) as on Mar-17. The number of investment centers have increased steadily and stand at 750+ by Aug-17. During this period of time, they have also come up with numerous job advertisements. I think, their increased expenses during Q1 can be correlated to the above activities and we can expect even better Operating Margins in the coming quarters.
I feel that, as we traverse deeper and deeper into the bull market, their operating margins and ROCE will keep on improving. @AlokBhola has mentioned above that, its ROE even touched 60% during the earlier capital market boom years!
Let me try to explain, why I believe that, companies like Arihant or Emkay which derive their maximum income from stock broking activities are likely to grow at higher rates of profits over the next many quarters/ years, as compared to other companies in its sector (capital market/wealth management/ stock broking) or other _NBFC_s or Housing Finance Companies. Stock broking business by its nature is such that, as the volumes increase, the topline (sales revenue) increases, but the bottomline (profit) increases in a disproportionately higher way. As per my judgment, this is due to the reason that, the business (due to its very nature) is able to handle more volume with less increase in the resources (employees, computer software etc.) and thereby lesser increase in cost.
Hence, we have a non-linear relationship between volume and the cost. As we get into more and more deeper into this bull market, more and more money pour into equity market, hence volumes for Arihant will increase proportionately. However, its profits will increase in a disproportionate way, as explained above. Let me substantiate this hypothesis with one more fact. ROCE is the primary measure of how efficiently a company utilizes its all available capital to generate additional profits. Arihant`s ROCE as of Mar-17 was around 28, whereas it was just around 9 in 2004, when market condition was not favourable. I think, Arihant will keep on improving its ROCE significantly from now onwards due to the reasons explained above.
What is the reason for the current bull run on the stock market and how long is it to continue (5 reasons why you can’t keep the bulls tamed on D-Street for long - The Economic Times)? Well, this is what the big bull Rakesh Jhunjhunwala said during early May this year: “Tsunami of local money will come into the local market. Morgan Stanley is predicting that USD 425-825 billion in the next 10 years to flow into markets”.
Even a person like Saurabh Mukherjea of Ambit Capital, who more often comes up with doomsday predictions and negative views about the market seems to be very bullish on stock broking and asset management companies and that too for a period of even the next 10 years.
Here is a summary of what he says: “People have realized that they cannot really expect to save through real estate and gold and hence formal financial savings will rise rapidly over the next 10 years. There is good reason to believe that now we have fallen out of love with real estate, there is good reason to believe that the amount of retail savings that will come into the stock market will continue accelerating over the next five to ten years. We are not very far away from the point where SIPs alone could be a billion dollars a month of inflows into the market and even that I think is scraping the surface. We have enough wealth in our country, enough savings in our country to believe that the SIP number can go considerably north of a billion a month. On all of those fronts, there is plenty of upside in this theme. There are fine credible companies, clean honest companies on the savings theme whether it is insurers, asset managers or brokers, buy them, sit on them for a long time. This is a safe theme which will give you good returns.”
Thanks to demonetization and interest rates reduction, Indian households have started pouring money to stock market and the above amount is steadily increasing quarter by quarter, especially after demonetization. Let us examine the actual data on this:
SEBI website (http://www.sebi.gov.in/sebiweb/other/mutualfunds.jsp) provides domestic mutual fund investment information. As per the data provided, I calculated that, for Q4’17, the MFs have invested Rs. 11,465 crores on equities in Indian market. During Q1’18, their investment was Rs. 29,708 crores. And, during the first two months of Q2’18 itself, they have already invested Rs. 29,741 crores, which already exceeded the total investment done during the 3 months of Q1’18!
The above money is unlikely to stop any time soon, for the same reasons mentioned by Rakesh and Saurabh above and there is good probability that, the money invested increases every month.
Yes, you are correct. They currently derive more than 80% of their revenues from the capital market activities. However, for all the reasons I mentioned above, I believe that, current positive cycle for the capital markets sector is going to stay here for a very long period of time (many years), with minor dips and highs in between.
Following is the breakup of net assets and profits for the parent company and the various subsidiaries, as provided in the latest Annual Report (http://arihantcapital.com/upload/financial_report/Annual%20Report%20copy.pdf):
Also, company has been experimenting on Affordable Housing as well as Housing Financing for some time now, though I have not been tracking much on those activities of theirs. Though they are doing it in a small way without adding any strain to their balance sheet, I feel that, they might have gained sufficient expertise in the above two businesses by now. Following is what their recent Annual Report says about their diversification of business:
“We believe in diversification and have added multiple revenue streams over the years. Our Company launched an affordable housing project in last fiscal, which we discussed in our previous annual report. We are happy to inform you that the progress of Arihant Residency project located in Pithampur has been promising. During the year under review, development of Sector 1 has been successfully completed and sale of plots is well under progress. Few families have already moved to their houses in the township enjoying a quality life. The Company also formed a new subsidiary in the name of Arihant Capital (IFSC) Limited during the year for establishing a unit in GIFT SEZ to provide international financial services.”
http://www.arihantlifespace.com/
Very true, this indeed is a very encouraging sign.
I believe that, their stock broking engine will fire on all cylinders in the coming few quarters and would provide them the sufficient cash flow to make them think about expanding their other businesses in a major way, including the affordable housing, housing finance and the Insurance broking.
There is a conducive market climate for all these businesses, hence we can confidently conclude that, they have picked up the right sectors/ businesses for diversification. Additionally, as we get more and more deeper into the bull market, all their capital market activities will generate increased cash flows.
In FY18, their focus would be on distribution and digitization. Let me quote from their recent Annual Report:
“The economic landscape in FY2018 is likely to be quite different from the one in previous years. The world of investing is changing. Technological changes are significantly impacting customer expectations, more and more investors are opting to invest in mutual funds {especially via the SIP mode} and the clients are looking for the best infrastructure at most competitive cost. The rapid speed of innovation, disruption in the financial technology space present challenges and opportunities and we are geared up for both.
We intend to capitalize on the growth of the retail brokerage industry, focus on attracting active traders, long term investors and franchises. The renewed interest in the equity markets will help us reach out to a wider population. We strive to enhance the client experience by providing wide range of investment products and services, enhanced trading tools and capabilities and unbiased objective advice customized to our customer’s needs."
From a broking house’s perspective, I think the key factors to consider would be the risk assessment of its customers and the legal relationships with them, protection of customer assets, financing of their Margin and the various other internal controls by the company. Company has also well documented many of the risk factors under the sub-heading “Risk factors relating to our business operations” on page 28 of the latest Annual Report.
However, from public media, I could not find much details regarding the specific risk mitigation measures taken up by the company. Here, my “intuition” has been that they understand these risks very well and as an ongoing process, will continue strengthening the mitigation measures, assisted by their software systems.
I am providing one example. Following is one thing that they claims at their website: “We have cutting-edge trading platforms and tools which include smart risk-management tools like conditional orders and alerts to help customer’s profits and limit losses”. I myself have not been a customer of Arihant, hence I cannot comment from a customers’ “feel” perspective here.
Hope, I have addressed all your queries in a reasonably good way. If you have any more specific questions, please do let me know and I will be more than happy to do a more thorough research on this company.