Separating chaff from grain

Any company which opts for IPO grading does not have a choice in accepting or rejecting the grade.

By Sudhir Nair | Print Edition: November 30, 2006

IPO grading is a globally unique concept introduced in the Indian market under the aegis of the Securities and Exchange Board of India (Sebi). Sebi has played a pioneering role in investor protection by increasing disclosure levels by entities seeking to access equity markets for funding.

This has caused India to be one of the more transparent and efficient capital markets in the world. However, these disclosures demand fairly high levels of analytical sophistication of the investor in order to effectively disseminate the information. Investment decisions for IPOs are at present based on voluminous and complex disclosure documents, which pose a challenge to investors to arrive at informed decisions.

Though seemingly there is a lot of information available on IPOs through free research on websites, media and other sources, investors often look for structured, consistent and unbiased analysis to aid their investment decisions. Moreover, information available on new companies varies with the size of the issue, the market conditions and the industry that the issuing company belongs to. IPO grading aims to bridge this gap and facilitate more informed investment decisions. Credit rating agencies registered with Sebi are authorised to carry out the grading.

IPO grading is optional for companies. Rating agencies have to forward the names and details of IPOs graded by them on a monthly basis to Sebi and stock exchanges for uploading on their website for public information. Any company which opts for IPO grading does not have a choice in accepting or rejecting the grade. The IPO grading given by rating agencies shall form part of the prospectus for the IPO.

Investors however should not misconstrue an IPO grading to be an investment recommendation. Investment recommendations are expressed as “buy”, “hold” or “sell” and are based on a security specific comparison of its assessed ‘fundamentals factors’ (business prospects, financial position, etc.) and ‘market factors’ (liquidity, demand supply, etc.) to its price. On the other hand, IPO grading is expressed on a fivepoint scale and is a relative comparison of the assessed fundamentals of the graded issue to other listed equity securities in India. As the IPO grading does not take cognizance of the price of the security, it is not an investment recommendation. Rather, it is one of the inputs to the investor aiding in the decision making process. Other things remaining equal, a stock with stronger fundamentals would command a higher price.

A Crisil IPO grade represents the agency’s overall assessment of the fundamentals of the issue graded in relation to other listed equity securities in India. It includes an assessment of business and financial prospects, management quality and corporate governance; and reflects Crisil’s understanding of these issues, particularly corporate governance (see box: Summary of Latest Assessment). It thus provides “an independent assessment of fundamentals” to aid comparative assessment of the investor. IPO fundamentals are graded on a five point scale from grade 5 (indicating strong fundamentals) to grade 1 (indicating poor fundamentals). The grading is a one-time assessment done at the time of the IPO and meant to aid investors who want to invest in the IPO. The grade does not have any ongoing validity. So far, Crisil has graded six companies.

By Sudhir Nair, Head, Crisil Research

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