Fundamentals, not investment viability, will decide IPO grades

MUMBAI: Investors, who intend to take cues from IPO grading by credit rating agencies (CRAs) to invest in the equity offering, could be in for some disappointment. This is because CRAs will grade a share issue only on the basis of its fundamental strength and not investment viability. In short, such gradings by CRAs would be more of a supplement to prospective IPO investors, who will have to judge whether a particular share issue is worth a buy or not.

Excited on the new business prospect, rating agency Crisil’s MD & CEO R Ravimohan told ET that the final call on the investment in an IPO has to be taken by the investor.

“We will see whether a company is good or not on the basis of some parameters. Based on this, the valuation and investment angles can be put together by investors,” he said.

Crisil intends to grade an equity issue on five parameters including business prospects of the company and industry, financial risks, management competence, governance and accounting quality. The grading will be on a five-pointer scale, with grade 5 indicating strong fundamentals and grade 1 poor fundamentals.

Mr Ravimohan said assigning weightage to each of these parameter during assessment would vary from one company to another.

Here, the bigger dilemma for the investor would be that the methodology used for grading the issue will vary from one CRA to the other. Since the concept of IPO grading is new to global financial markets, the track record of CRAs for such grades is yet to be tested.

“Over a period of time, the market will differentiate between a good IPO grading and others, just like ratings of debt issuances,” Mr Ravimohan said.

Investment bankers, however, remain sceptical about the implementation of such gradings, as existing market sentiment also plays a key role in valuation and pricing of an equity issue.

“The proof of success of IPO gradings can be ascertained only if there is a positive correlation between the grading and share price performance post listing,” said an investment banker.

Mr Ravimohan feels a more apt indicator for the proof of success of this concept would be the correlation between the grading and EPS growth, as CRAs analyse the fundamental strength of a company.

“If the PE ratio of companies (which has been graded) do not fall as much as the broader market is weak, then it can be said that the response is positive,” he added.