Zerodha reaches the cusp of moderation after 12 years of scorching growth

Online brokering firm Zerodha.

If you cannot do great things, do small things in a great way, according to American author Napoleon Hill.

Hill may not have inspired new-age broking firm Zerodha’s founder Nithin Kamath but the firm’s story closely resembles the statement’s profundity.

The stock broking firm has surpassed the biggest broking companies in the industry to tower over them in size and profitability over the past 12 years.

Kamath formed Zerodha in 2010 as a solution to the problems he encountered as a trader. At that time, the stock market was just emerging from the blow of the 2008 financial crisis and equity had become a four-letter word in investments. Retail participation was wanting and investors had to contend with high brokerage fees and charges along with opacity from stock broking firms.

Kamath’s aim was to bring in technology to simplify the trading process and reduce costs for market participants. Discount broking had gained in popularity as more and more Indians began to explore the equity markets.

To be sure, traditional brokerage firms that offer bundled investment services still hold a strong place among investors but those looking for pure stock trading or even equity investments seem to prefer Zerodha.

While Zerodha’s success has been consistent over the years, big bang growth and profitability have come in the past two years.

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Drumming up the growth song 

Covid-19 surely enthused Indians to put their savings into equities and try a hand at stock trading. The surge in demat accounts during FY21 and FY22 is a testament to this fact.

Zerodha has been the biggest beneficiary of this but to limit the firm’s success to these years would be a disservice to it. The growth in Zerodha’s client base has been spectacular almost every year from the beginning.

Although the doubling of clients in the initial years can be attributed to the low base, the pace of growth hasn’t waned yet. Indeed, the company now boasts of a whopping 10 million customers, a five-fold leap from 2 million two years ago, according to the company’s website.

Its active clients exceed that of the nearest competitors, both traditional and new age discount brokers, by a mile.

Zerodha’s active clients are now more than 6 million, double the number it had in FY21. As said earlier, the company has been doubling its client base every year without fail.

An early spurt of growth came in 2015 when the company made delivery trades free. Many customers began intraday trading as well for which the firm charged a flat fee. This lifted its customer base from a mere 0.03 million to 1.4 million in just five years.

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A warning on this unbridled growth has come from founder Kamath himself. Equity markets are in troubled waters of late owing to adverse global developments. The novelty, along with easy access, that led many Indians to take to trading during the pandemic is now gone.

In an August 16 write-up on the firm’s website, Kamath had this to say, “While the last two years have been phenomenal, we are seeing a plateau in trading activity and a 40% drop in new user addition since the market topped earlier this year.”

He also flagged concerns about overestimation in the equity market participation metrics. In July, Kamath pointed out that active clients may be higher but trade volumes are overstated. Besides an unfriendly market, the company also faces stiff competition from other discount firms that also offer similar tech-based trading.

Having fought off traditional goliaths such as ICICI Securities, Kotak Securities and the like, battling Upstox, Groww, Angel Broking and SAS Online seem to be easier. After all, Zerodha is already a market leader, which gives it an edge over competition. Its thrifty approach to costs will also keep it in good stead.

Regulatory challenges 

The Securities and Exchange Board of India (SEBI) has prescribed a slew of norms that brokerages have to adhere to in order to keep the process of investing and making money clean. From position limits to client margins, SEBI ensures that investors don’t indulge in risky bets and brokers refrain from questionable practices.

SEBI’s recent rules, which tightened the noose on client margins, amped up the requirement of disclosures both in quantity and frequency. The capital market regulator has also been quick to take punitive action against transgressions.

While Kamath supports the tightening of regulations, he believes that a short-term impact on business cannot be ruled out. While being superior in technology has been a big distinguishing factor for the company, Zerodha, too, has faced glitches. In July, a bunch of demat accounts were said to have been hacked on the platform.

Kamath assured investors that the number of accounts affected was minimal and the company would introduce a new safety tool. He said last year the company witnessed only 100 complaints of fraud out of 6.5 million customers. Kamath has also beefed up support services to ensure that traders are able to trade seamlessly.

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Big bang bucks 

Notwithstanding Zerodha’s scorching growth, doubts about sustainability of discount broking have been lurking around.

Being a volume-focussed business, discount broking needs to grow its client base fast and also show large trade volume. Kamath attributes his profitability to the company’s frugality in costs and the increase in the active trader base that bring in the big bucks.

“Today, we have not only the largest group of active retail investors in India, but also active traders. Traders who pay fees and, in turn, help keep investments for free,” he said in his write-up.

New-age peers have begun to charge customers for investments, though Zerodha still offers them for free, he added. The company is perhaps one of the very few profitable firms in the new-age startup space. It reported a net profit of Rs 1,122.31 crore in FY21, nearly three times the previous year, and this came on the back of a similar surge in revenue.

Kamath’s frugality in costs is a key feature that enables the firm to report strong profitability and this is expected to continue. The company is also debt-free unlike other peers.

Even as he has warned about growth getting impacted, Kamath said the firm has enough capital to keep growing for the next 13 years even without generating revenues.

“We have sufficient capital to continue running our business for 13 years, even if our revenue went to zero,” he said in his write-up. The upshot is that even as volumes may get impacted, the company will continue to generate profit. For a discount broking firm, that is perhaps the best outcome.