Widely read:
Grading of an initial public offer or IPO, which had earlier been made mandatory, is now optional. Sebi recently came up with new guidelines upon the request of Investor Associations and Association of Investment Bankers of India (AIBI). The decision came after much debate on the grading system as it was argued that these ratings can't be a basis for investment. Ratings only talk about the fundamentals of the listing company and have nothing to do with the valuations.
What is IPO grading?
According to Sebi “IPO grading is the grade assigned by a Credit Rating Agency (CRAs) registered with Sebi, to the initial public offering (IPO) of equity shares or any other security which may be converted into or exchanged with equity shares at a later date. The grade represents a relative assessment of the fundamentals of that issue in relation to the other listed equity securities in India. Such grading is generally assigned on a five-point point scale with a higher score indicating stronger fundamentals and vice versa as below.”
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
How important is grading?
While we have always said that one can't completely rely on grading or other ratings for any securities in the market by CRAs, it can't be ignored completely as well.
For any IPO to be monetised two factors are very important: fundamentals and valuation. Valuation is difficult to assess for a new company joining the bourses because of non-availability of historic data and sometimes non-comparable peer. Fundamentals, on the other hand, is very subjective but gradings do give a fair bit of idea about a company, if not the clear picture. The underlying factor to investing is that it is the fundamentals of the company which are the most important factors. That is the same conclusion we have drawn from the analysis of the IPOs in the past 5 years. The rating given to the said IPO was also taken into account.
To analyse, we invested such an amount in each of the issues so that each grading category has Rs 50,000. We then compared their current values and found that lower the grading, lower the return it has given. Also, we invested Rs 50,000 in the Sensex to check what would the Sensex have yielded if invested into it, than putting the money into the IPO.
Disclaimer: This content is for information only and should not be considered investment advice or a recommendation.
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