IPO grade alone has nothing to do with performance

Business Line had a very good piece on IPO Grading and stock returns on Indian IPOs in the last two years or so (January 2007 – October 2009).

They looked at 66 IPOs in that time frame and measured their returns till date. Turns out – the best performing IPO was Edserv Softsystems with a return of 265.9%, but it had the lowest grade of 1. In fact, the top 4 performers were graded just 1 or 2. And the fifth best performer was graded 3.

Before you make up your mind, and start looking for IPOs with poor fundamentals, take a look at the worst performing of the lot too.

The 4 worst performers were graded 1 or 2, and the fifth worst performer was graded 3. If you take a closer look at the results, you will find that there seems to be very little correlation between grade and performance.

This clearly shows that no one should invest in an IPO by grade alone. As I have written earlier, IPO grading doesn’t take into account a very significant factor – price.

When the rating agencies award a grade to the company, they take into account several factors, but not the price at which the issue is coming out. Everything is relative to price, so without that key input, — you can’t rely on grading alone.

The purpose of IPO grading is to tell you about a rating agency’s view about the company’s fundamentals, management standard and factors that will impact how well it does in the long run. It is not a tool that tells you whether you can make listing gains or not.

If you are in an IPO to make a quick buck, and sell on listing, — then be aware of the fact that you are playing a risky game, and no grading can be surefire.

If you are really looking to invest in a company, then IPO grading can help you understand the fundamentals of the company. If you like something, you can invest in it, even after the IPO is over, or looking at today’s environment, especially after the IPO is over, and the stock lists on the market. Not many Indian IPOs have done well on listing, and it might be better to wait and buy the stock when it lists rather than invest in the IPO and have all the cash blocked.

So, even though IPO grading may not help you make listing gains, there are other ways in which you can use it.

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