Friday, January 9, 2015

IPO Grading and Its Usefulness


Grading of Initial Public Offerings (IPOs) is a service aimed at facilitating assessment of equity issues offered to the public. The Grade assigned to any individual IPO is a symbolic representation of assessment of the “fundamentals” of the issuer concerned relative to other listed securities. IPO Grades are assigned on a five-point point scale, where IPO Grade 5 indicates the highest grading and IPO Grade 1 indicates the lowest grading, i.e a higher score indicates stronger fundamentals. An IPO Grade is not an opinion on the price of the issue, pre- or post-listing.

  • IPO grade 1: Poor fundamentals
  • IPO grade 2: Below-average fundamentals
  • IPO grade 3: Average fundamentals
  •  IPO grade 4: Above-average fundamentals
  • IPO grade 5: Strong fundamentals

IPO grading has been introduced as an endeavor to make additional information available for the investors in order to facilitate their assessment of equity issues offered through an IPO.
The IPO grading process is expected to take into account the prospects of the industry in which the company operates, the competitive strengths of the company that would allow it to address the risks inherent in the business and capitalize on the opportunities available, as well as the company’s financial position.

 IPO Grading: Conceptual Issues

IPO grading is a service intended to facilitate the assessment of equity issues offered by unlisted companies to public. The grade assigned to any individual issue may represent a relative appraisal of the ‘fundamentals’ of that issue in relation to the universe of other listed equity securities in India. In fact, IPO grading is positioned as a service that provides ‘an independent assessment of fundamentals’ to assist comparative assessment that would prove useful as an information and investment tool for prospective investors.

The methodology of such grading is to consider five-point scale with a higher score indicating stronger fundamentals. While investment recommendations are expressed as buy, hold or sell securities and are based on a security specific comparison of its assessed ‘fundamental business strength’ (such as business prospects, financial position etc.) and ‘market factors’ (liquidity, demand supply etc.) to its price, IPO grading is expressed on a five-point scale as stated earlier. In other words, it is a relative comparison of the assessed fundamentals of the graded issue to other listed equity securities in India.

The cost of IPO grading shall be borne from investor protection funds administered by stock exchanges or from Investor Education and Protection Fund (IEPF) administered by the Ministry of Companies Affairs. SEBI would finalize necessary procedural aspects in consultation with Stock Exchanges IPO grading covers both internal and external aspects of a company seeking to make an IPO in general. The internal factors include competence and effectiveness of the management, profile of promoters, marketing strategies, size and growth of revenues, competitive edge, technology, operating efficiency, liquidity and financial flexibility, asset quality, accounting quality, profitability and hedging of risks. Among external factors, the key one is the industry and economic/business environment for the issuer.

Here, it is important to note that internationally, the global rating agencies such as Standard & Poors and Moody’s do not perform grading of IPOs at all. While Standard & Poors is the majority stakeholder in CRISIL Ltd, Moodys is the single biggest stakeholder in ICRA Ltd. Similarly, the third global player Fitch IBCA (which acquired another rating agency Dun & Bradstreet in 2000) also does not grade IPOs as yet.
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