The number indicates the following:
1: Poor fundamentals
2: Below average fundamentals
3: Average fundamentals
4: Above average fundamentals
5: Strong fundamentals.
The most important thing about IPO Grading is that it doesnâ€™t consider price. I feel that this is an important aspect because everything is relative to price. What good is a company with strong fundamentals, if they are over charging you?
Most companies that come out with IPOs these days are not leaving anything on the table for investors, so that makes the price aspect even more important.
That means you canâ€™t take a look at the IPO grading, and make a decision to buy. If the company has poor fundamentals or below average fundamentals, then you can decide not to participate in the IPO, but you canâ€™t take a decision to buy based on the grading alone.
A company rated 5 has strong fundamentals, but how do they stack up relative to the price? The IPO grading doesnâ€™t tell you that. It doesnâ€™t tell you whether the company has left anything on the table for the investors or not, and therefore you donâ€™t know whether the issue is worth subscribing or not.
Have I emphasized this point enough?
Okay, now on to what the grading does take into account.
IPO grading takes into account the prospects of the company, industry it operates in, financials, management strength, corporate governance, litigation history and the prospects of its new projects.
A company which takes out an IPO needs to get their issue graded, and doesnâ€™t have an option to reject the grading. If they donâ€™t like the grading, they can get a second opinion, but have to disclose everything that they got in the offer document. The company does pay the rating agency for the grading, so there is a conflict of interest, which is characteristic of this industry.
IPO grading was introduced to help investors with one more data point, and enable them to make a better decision. It is a useful thing to know about, but without including price in the score, it lacks a serious element needed to make a decision.