Best grades don8217;t equal top IPO stocks

An analysis by The Indian Express revealed that of these 62 companies,the share price of just about 40 per cent are currently trading levels higher than their listing price. This,despite the fact that most of these IPOs were given a rating of 3 or 4,indicating their average or strong fundamentals for investors.

The question that then needs to be asked is whether investors,especially retail investors,need to pay too much attention to the grading given to IPOs?

Investors who participated in IPOs of state run SJVN Ltd or the privately held Bajaj Corporation,each of which were assigned a grade of 4,signifying above average fundamentals have suffered negative returns,the same as those with low grades.

SJVN Ltd was graded 4 by Crisil but by October 29,2010,it8217;s share price had fallen by 14 per cent from its listing price of Rs 28. Similarly,Bajaj Corporation that was assigned a grade of 4 by Crisil saw its share price fall by 11 per cent in the same period.

Said Prithvi Haldea,CMD,Prime Database,Our studies have shown that IPO grading has almost no correlation with the post listing performance of a company. In fact,most high graded IPOs have done badly while several lowest graded IPOs have done exceedingly well post-listing and on a sustained basis.

Further,domestic bourses too have recovered from the crash of 2008. The 30-share sensitive Bombay Stock Exchange BSE Sensex has shot up by 26 per cent since September 1,2009 to close at 18,027.12 points on September 30,this year. A month later,it crossed the 20,000 point barrier. Similarly,in the same period,the Nifty Fifty climbed up nearly a 1,000 points or 19 per cent.

Ever since market regulator Sebi made it mandatory in 2007 for unlisted companies to get their initial public offers graded,the issue has been a virtual hot potato with India Inc,rating agencies,merchant bankers and the regulator putting forth differing views.

IPO grading was optional when it was introduced in 2006. But starting May 1,2007,Sebi has made it mandatory for all unlisted companies filing their prospectus to get their IPOs graded.

The cost is borne by the issuer. Rating agencies such as Crisil and Care grade companies on a scale of one to five,with five indicating strong fundamentals. India is incidentally one of the only countries in the world that follows this exercise.

The rationale behind IPO grading was simply to help retail investors take a more informed decision based on the fundamentals of the company and the disclosures made by it,but many have used it as a buy or sell advice.

As per rating agency Crisil,IPO grading is not a recommendation to invest or not to invest. The aim is to give some perspective to investors on the fundamentals of a company. Even if an investor is investing for the short run,the company has to raise funds for the long term and so it is essential that it provides a fair idea about its prospects, said Tarun Bhatia,director,capital markets,Crisil Research.

Crisil has been in the business of IPO grading ever since it was introduced in 2007. It uses four key parameters of business prospects,financial prospects,management quality and corporate governance for the exercise.

Credit Analysis and Research Ltd or Care Ratings,that also provides IPO grading services has said on its website,IPO grading would help investors,particularly retail investors better understand the meaning of disclosures in the issue document to the extent that they affect its fundamentals.

But Haldea countered,An equity investment is subject to several internal and external risks,and cannot be rated; no body in the world does it. Assessing only the fundamentals can be of very limited use,and can bring in subjectivities. Moreover,as grading does not factor price,the exercise becomes redundant. Investors want stocks that give returns ,not that are graded high on fundamentals on a given date,but lead to losses. Fortunately,Indian investors have still not relied on gradings for their investment decisions.

Significantly,the Securities and Exchange Board of India recently decided that initial public offerings will continue to be graded without any comment from rating agencies on the issue price. Since IPO grading does not consider the issue price,the investor needs to make an independent judgment regarding the price at which to bid for/subscribe to the shares, Sebi has explained in its website.

Merchant bankers have been for long pressing the regulator for a review as they felt that grading did not add any particular value to the investment decision of retail investors But just increased the cost of compliance as the issuing company had to bear the fees of the rating agency.

This should not be called an IPO grading but can be called a rating of the company as it is based on its performance. If an IPO is being graded,then it must include the issue price, said Jagannadham Thunuguntla,head of research at SMC Global Securities.

In a report released in August last year,SMC Capital had questioned the exercise of IPO grading on the grounds that it failed to insure investments. Of all the IPOs that came after the introduction of mandatory IPO Grading requirement,IPOs in all grades faced substantial wealth erosion in the range of 20 per cent to 70 per cent irrespective of their Grading. Interestingly,the IPOs with Grade 4 have underperformed than that of IPOs with Grades 3 and 2, it said.

The report also noted,After about more than two years of its commencement,it raises the question whether is this really serving the purpose of guiding the investors. This is because the investors who have invested in IPOs with Grades 2 and 3 have fared better than that of the investors who have invested in IPOs with Grade 4.

Meanwhile,Crisil has also conducted two studies on the impact of IPO grading on post listing performance one in May 2009 and the other in January 2010. The January 2010 study of 56 listed IPO graded companies revealed that companies with a higher graded IPO command a higher price earning ratio.

An analyst with another rating agency said,The grading assigned to any individual issue represents a relative assessment of the fundamentals of that issue in relation to the other listed companies. But,as the IPO grading does not take cognisance of the price of the security,it is not an investment recommendation.

The jury is still out on the whole exercise with views and counter views being put forth. But the debate has clearly pointed out that there8217;s no magic mantra to enjoy sustained investor interest.

As Bhatia said,IPO grading is just one input to the investor. There are several other factors that determines the post listing performance of a company,such as risk appetite of investors,pricing of the issue and market conditions.