IPO: Look before leaping

It’s time retail investors punish fundamentally weak IPOs

In recent times, much has been said about the poor performance of newly-minted public companies, as almost 70 per cent of these have eroded investor wealth on listing. The figures are staggering — almost 70 per cent of initial public offers (IPOs) have not delivered returns and shareholders have lost close to Rs 3,600 crore on listing of these dud issues. While the concern of the regulator is valid on companies tapping the capital market at high valuations, it’s time investors punish issues with poor fundamentals.

Thanks to the Securities and Exchange Board of India making grading of public issues mandatory from 2007, investors have a good tool to evaluate the fundamentals of a company and its management. Weak issues get a lower grading, while those with sound fundamentals get a higher rating. While the grading is not a commentary on the price of the issue, it gives a fair indication about fundamentals of a company and its management. A study done by CRISIL shows that since IPO grading was introduced in 2007, only three per cent IPOs, in 2010 of got a 5/5 grading. In the previous years, none of the companies managed the perfect score of 5.

CRISIL Equities’ fourth consecutive analysis of listed IPOs graded by rating agencies shows that companies with higher grades continue to command higher price-to-earnings (P/E) multiples. Interestingly, companies with a 5/5 grading traded at almost 80 per cent premium to 1/5 graded companies. Clearly, the market gives a premium to the quality of management and sound fundamentals. Says Mukesh Agarwal, director, CRISIL Research, “Higher IPO graded companies will most likely command higher P/E multiples in the long run, as fundamentals will overrule the quintessential emotions of greed and fear.”

Rather than evaluating fundamentals and comparing financials with that of peers, investors seem to be getting carried away by marketing hype and the blitzkrieg of merchant bankers. Some merchant bankers even admit that often institutional investors are told the issue will be oversubscribed by a certain multiple and applications should be that many times more to get a proportionate share of shares. Consequently, investors bid for higher amounts, fearing oversubscription. This creates an artificial demand or over-subscription of the issue. It’s time investors take a hard look at numbers and penalise companies with poor fundamentals.