AA, AAA, A+…Grades such as these are assigned by rating agencies to most financial instruments based on several parameters. Even if you don’t understand why these grades have been given, you do know that the better the grade, the higher the chances of good returns. So, when Sebi made it mandatory for companies to have their initial public offerings (IPOs) graded, it sounded like a great idea. The higher the grade, the better the IPO’s prospects; or so we thought. Sadly, we were wrong. The grades do not reflect the future performance of the issue in the stock market.
Consider this. Both Allied Computers and Orbit Corp were given grade 1, the lowest grade. But Allied shares have risen 75% over their issue price, while Orbit has risen almost 330%. Gammon Infrastructure, however, got a high grade of 4. The stock is now 4% less than the issue price. What does this mean? It means, quite simply, that the IPO grade does not rate the offering; it only rates the company.
The grades reflect only the company’s fundamentals and not the future performance of the issue. A look at the table below almost proves a contrarian’s point—the lower the grade, the better the performance. Of course, you know that judging a stock is not the only way to long-term wealth creation. As Warren Buffett says, you’re not buying a stock; you’re investing in a business. That’s where the so-called IPO grading can help. It tells you how sound the company’s fundamentals are—a grade of 5 means strong fundamentals, and 1 is the poorest.
Terming the rating an “IPO grade” is misleading. If the grading were to try rating the issue itself, it should take into account the price at which the shares are offered. In its current form, the grading just assesses the company and its prospects without stating whether the shares being offered are worth their price or not. “Grading without factoring in the price is meaningless. A good company at a high price is a bad investment,” says Prithvi Haldea, MD, Prime Database.
“Pricing of shares is the most critical factor in evaluating IPOs and by not taking pricing into consideration, the usefulness of grading is diminished,” adds Mridul Sagar, chief economist, Kotak Securities. As Amar Ambani, vice-president (research), India Infoline, says, “We may not promote the IPO despite a good grading if it is at an unjustifiably high premium.”
"Grading IPOs without factoring in the price is meaningless. A good company at a high price is a bad investment."
— Prithvi Haldea, Managing Director, Prime Database
How some graded IPOs have performed
|COMPANY||IPO GRADE||ISSUE CLOSE DATE||OFFER PRICE||*CURRENT PRICE||% CHANGE (OVER ISSUE PRICE)|
|Varun Industries||1||31 Oct 2007||60||68||12.5%|
|Allied Computers International (Asia)||1||23 Oct 2007||12||25||105.4%|
|Saamya Biotech (India)||1 ||28 Sep 2007||10||8.7||-12.7%|
|Ankit Metal & Power||1||22 Jun 2007||36||80||123%|
|Celestial Labs||1||22 Jun 2007||60||48||-19%|
|Orbit Corporation||1||23 Mar 2007||110||463||320.6%|
|Gammon Infrastructure Projects||4||13 Mar 2008||167||145||-13%|
|IRB Infrastructure Developers||4||5 Feb 2008||185||188||-1.7%|
|OnMobile Global||4||29 Jan 2008||440||605||37%|
|Reliance Power||4||18 Jan 2008||450||191#||-18%|
|Precision Pipes & Profiles Company||4||20 Dec 2007||150||82||-45%|
|Transformers & Rectifiers India||4||12 Dec 2007||465||384||-17.5%|
|Jyothy Laboratories||4||27 Nov 2007||690||504||-27%|
|Edelweiss Capital||4||20 Nov 2007||825||673||-18%|
|* Price as on 17 June; # Adjusted for 3:5 bonus issue|