Look beyond the rating

Rating methodology

The IPO rating process is qualitative. A relative assessment of the company is done based on parameters such as business fundamentals and prospects,financial position,management quality,corporate governance practices,project risk,and compliance and litigation history.

The rating procedure commences when the company planning to raise money in the primary market requests a rating agency to rate it. The company then submits all the relevant information and its offer document. The rating team analyses the information furnished by the client. It also interacts with the client. The latter responds to queries raised and provides additional data that might be required. The rating team also undertakes site visits. It interacts with the promoters and heads of strategic business units SBU to assess the strength of the management team. It also speaks to the companys independent directors to assess how robust are the companys corporate governance practices.

Thereafter,the rating agencys internal committee previews the analysis. The rating committee then awards a rating to the client.

According to D.R. Dogra,deputy managing director,Credit Analysis amp; Research CARE,The client may ask for a review of the grading assigned and may furnish additional information for that purpose. However,clients do not have the option of not accepting the final grading. He adds: The company may opt for multiple ratings by applying to more than one rating agency,but it must disclose all these ratings.

Rating scale

Companies are assigned grades on a five-point scale where the highest grade of 5/5 signifies that the fundamentals of the company are strong relative to other listed securities in India. A grade of one,on the other hand,indicates that the fundamentals of the company are poor relative to that of other listed securities. The grades of some rating agencies such as CRISIL Research,CARE and Fitch Ratings India,and their interpretation,are given in the table.

Additional info at website

Apart from the grade which is there in the red herring prospectus RHP of the company,a detailed grading rationale covering all the grading parameters is also available on the rating agencys website. If an investor needs additional information or clarification on a particular case,he can contact the rating agency.

Limitations of IPO grading

Any investment decision has three components: one,is it a good company evaluation of the companys fundamentals? Two,is it available at the right price valuation decision? And three,is it the right investment for me assessment of the investors own risk appetite?

IPO grading addresses only the first component of the investment decision-making process analysis of the companys fundamentals. According to Chetan Majithia,head-equities,CRISIL Research,IPO grading does not solicit investors to subscribe to the issue. It also does not convey the appropriateness of the pricing of the IPO issue. The grading does not even comment on the future market performance and earning prospects of the issuer.

Valid for a fixed period only

Some rating agencies define a fixed period for which their IPO ratings remain valid. It is six months in the case of CRISIL Research and four months in the case of CARE. In case of delays and if the validity period has expired,the company can ask for a re-rating of its IPO, says Dogra. According to Rakesh Valecha,senior director,Fitch Ratings India,The IPO grading is a point-in-time assessment. The company is not monitored after the initial assignment.

Positives and negatives

Many of the companies that tap the IPO market are small and mid cap companies. The market may not have complete information about their managements track record in conducting the business. Information about the companys corporate governance practices may also be incomplete. In such a scenario,IPO grading does add to investors knowledge about the company.

The drawback of IPO ratings is that they do not offer a complete answer to the investors question whether to invest in the IPO or not. It does not capture the link between fundamentals and price. So the decision whether to buy or not cannot be taken on the basis of IPO grading alone, says Veer Sardesai,a Pune-based financial planner.

The other concern relates to the validity of the rating. From the point when the rating is assigned to the time the company goes for listing,there can be material changes in the business environment and fundamentals of the company. The rating wont factor in the changes during the interim period, points out Vishal Dhawan,a Mumbai-based financial planner.

Bottomline

Gradings do add to investors knowledge in case of companies that are not very well known. Says Majithia: The grades are meant to be used by investors in conjunction with their personal risk appetite,price and return considerations.

In addition to looking up the ratings of an IPO,some additional due diligence needs to exercised by investors. They should learn about the company from the prospectus. Further,according to Sardesai,Look at other companies in the same industry and compare their price-to earnings ratio PE and growth prospects. Thereafter,see whether the fundamentals justify the pricing of the IPO. If one finds that other companies have higher growth prospects and are available at a more attractive price,then invest in the secondary market where more information is available on stocks, says Sardesai.

Thus,IPO grading should be used by investors only as a guidance tool. If investors go merely by the grading,they will have cause to regret in future. u

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