Shun Greed, Look at Grades

Did you check the grade awarded to the IPO (initial public offer) that you invested in recently? Grade! What? Did we hear you say that? Relax. You are not the only one who is not aware of the need to look at the grading given to an IPO to get a better picture of what returns your investment might give you in the long run. Or, maybe you are just not bothered, even if you know that since 2007, all IPOs need to get a mandatory grading from a rating agency that indicates the fundamentals of the company.

The IPO market is driven by the hunt for short-term listing gains, a fact reflected by the subscription figures of issues of companies with below-average fundamentals. In 2010, which saw the revival of the IPO market in India, out of the 65 issues that hit the market, even lowgraded issues (below 3) received an average subscription of about 7.5 times (See Tracking IPO Grades).

Check this out. ARSS Infrastructure Projects, an IPO graded 2 got subscribed 19 times by retail investors. The retail subscription for Microsec Financial services was over 11 times despite a low grade (See The Rise and Fall of Below-Average IPOs). Such IPOs may have listed at a premium but their performance today is a clear vindication of the view that long- term investors must look at grades.

In 2009 as well, 6 out of the 21 IPOs that were graded below 3 received an average subscription of over 5 times. Thinksoft Global Services and Excel Infoways, among them received subscriptions of over 10 and 8 times, respectively. greed, it seems, ruled sentiments despite the fact that many burnt their fingers in the market crash of 2008. Some IPOs that got listed in 2008 are still trading below their listing price, some having tanked by as much as 90%. For instance, Resurgere Mines and Minerals which got listed in August 2008 closed at Rs 0.87 on March 1, 2011, 90% below its listing price (adjusted for corporate action) of Rs 9.068. It originally listed at 272 agianst the issue price of Rs 270. Nu Tek India closed at Rs 11.05, on March 1, 2011, 89% below its adjusted listing price of Rs 100.55. Nu Tek’s original listing price was Rs 201 against an issue price of Rs 192.

A PEEP INTO THE BUSINESS

IPO grading was introduced by the Securities and Exchange Board of India (Sebi) in 2006, in order to provide investors with additional information on the fundamentals of companies seeking to raise money from the public. CRISIL, ICRA, Credit Analysis and Research Ltd (CARE), Fitch Ratings and Brickwork are among the agencies registered with Sebi for grading.

While grading an IPO, a rating agency takes into account the financial history and outlook of the company, its business prospects as well as the industry outlook, background of the promoters and corporate governance issues. “When we say an assessment of fundamentals, we basically mean an analysis of the company’s operations, its financial strength, an analysis of the industry within which the company operates and the growth prospects of that industry. It also involves an in-depth analysis of management quality and corporate governance practices of the company,” says DR Dogra, managing director and chief executive officer, CARE.

According to Ashutosh Maheshvari, chief executive officer, Motilal Oswal Investment Advisors, the past performance of the company carries a lot of weight. “The grading agencies look at financial ratios such as the debt-equity ratio and return on equity,” he adds.

THE MISSING LINK

Often, small companies looking for blockbuster listings, price their issues low. Says Gesu Kaushal, associate director, Kotak Investment Banking, “For oversubscription or the post-issue listing performance, the other equally important factors are pricing of the issue and market environment, both not considered while grading the IPO.” The two factors helped 16 of the 27 IPOs graded below 3 in 2010 to list at a price higher than the issue price while only six got listed at a discount. The rest debuted at the issue price. Out of the issues that were graded over 2, about 30 of 38 got listed at a premium.

In the long term, however, a lot of factors—usually taken into account while grading an IPO—may impact a company’s performance and the stock price. “All retail investors do not have the same risktaking ability, hence the more conservative ones may want to stick to investing in IPOs graded higher than 1 or 2 and consequently take lower risks,” says Jyoti Prasad, head, investment banking, Asit C Mehta Investment Intermediates.

In the longer term many below average IPOs have struggled to get back to their listing levels. In 2010, 23 out of 27 below-average grade issues were trading below their listing price as on March 1, 2011 (Some are listed in The Rise and Fall of Below-Average IPOs). Of the 2009 IPOs, six were below-average grade issues and five of them were trading below the listing price. Only 6 out of the 14 above-average grade issues were trading below their listing price on March 1, 2011.

The Coal India IPO last year proved that a company with a good grade—it was assigned grade 5 by credit rating agencies—fetches good long-term returns. The IPO got listed at Rs 287.75 against the issue price of Rs 245 and still trades above its listing price. On March 1, 2011, it closed at Rs 317.5.

With a host of companies planning IPOs in 2011, a look at their grades will help you pick the right ones. Happy investing!