Much has been written in the media about the efficacy of IPO ‘gradings’. IPO gradings are grades issued by rating agencies as to the fundamentals of a company without making a judgment on the value of the company. Thus Infosys (if it were to come out with an IPO now) would get the highest grading but, an offering of its shares at 20,000 rupees would clearly not be attractive – and the offer would thus be value destructive for an applicant. As the rating agency offers no opinion on the price, investors are expected to balance the grade with the offer price before subscribing.
Hindu Businessline has a piece “IPO grading makes little difference to the returns” on why you should not rely on IPO gradings. Many have asserted its failure on the grounds that those issues which are highly rated in fact provide less return that those which are graded lowly. In fact if that is the case, that in fact shows the efficacy of the grading process. It was stand to logic that people would pay a lower price for a poor quality IPO companies and a higher price for highly graded IPO companies. Also given the respect a higher graded IPO should command, it is no surprise that they are able to leave less money on the table and therefore a less steep discount to the market is provided to shareholders.
One could also safely conclude that in a frothy market with substantial speculative trades, the lowest grades would do well and the better offers in quality, which have left little money on the table for the investors, would not. The same cannot be said over a longer period of time when better run companies with superior corporate governance are likely to outperform the shooting star – low grade companies.
While I am not the biggest votary of IPO grading, I think this result strongly supports such a compulsory grading rather than debunking its usefulness. Clearly, we must wait longer before coming to a definitive conclusion on the usefulness of gradings.
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