What An IPO Grade Can And Can’t Do For Investors - June 3, 2008

The grading of an initial public offer (IPO) is a new product, launched in mid-2007 by CRISIL. It is the first time that a product like this has been launched anywhere in the world. It is important for investors to understand how to use the product correctly, so that they can derive best value from it. Properly used, IPO grading can empower you, the investor, to take considered and informed investment decisions.

An IPO grade reflects CRISIL’s opinion on how strong the company making the IPO is on fundamental parameters—business prospects, financial performance, management capability , and corporate governance—compared with other listed Indian companies.

In other words, it is an expert opinion on the “quality” of the company. CRISIL makes IPO grades available free of charge to all investors. You will see the grade displayed in the company’s IPO prospectus , advertisements, and application forms. The grades are assigned on a self-explanatory scale, from 1/5 to 5/5, with 5/5 being the highest grade.

What an IPO grade can’t do

So far, investors have been getting equity research and research on IPOs that conclude with a simple “Buy” , “Hold” or “Sell” recommendation . An IPO grade, by contrast, is neither an opinion on the issue price, nor a recommendation to buy, sell, or hold the shares. It is also not an opinion on the shares’ future market price or their suitability for a particular investor.

In other words, as an investor you should not use the IPO grade to assess whether the price of the IPO is right. For this, there are numerous other tools that are commonly used, among them a comparison of the price/earnings (P/E) ratio with that of other companies in the same peer group, and analysis of the P/E to growth ratio.

Second, the grade is no indication of how many times the issue will be subscribed—this depends on factors such as liquidity and market sentiment, which are unrelated to the fundamentals of the company.

Thirdly, the grade gives no indication of the price at which the issue will open, or the returns that are likely from the issue—technical factors can weigh heavily on opening prices, and returns will depend on investment time horizons.

And lastly, the IPO grade by itself does not tell you whether the IPO is a suitable investment for you. That depends on your age, the composition of your current investment portfolio , family situation, and requirement of money . A good financial advisor is the best person to help you with this.

How you can use the IPO grade

CRISIL believes that, as an investor, you need to answer three questions before deciding to invest in an IPO. Firstly, how strong is the company on fundamentals? Second, is it being offered at the right price? And third, is this the right investment for you?