What is IPO Grading? Its Working & Importance
In India, IPO grading is an important tool for investors to evaluate an IPO before it enters the market. This process is carried out by authorised credit rating bodies that analyse the company’s monetary condition, managing capabilities, and plans. Moreover, by establishing a straightforward scale, IPO grading enables buyers to make informed choices. Thereby reducing the risks involved in investing in new public companies. Furthermore, IPO grading is of great importance to all investors since it can vastly improve their investment strategy. In this blog, we will discuss how IPO grading works, factors to consider, its importance, grading scales, and when it shouldn’t be practised.
Key Highlights
- ‘Grading IPOs’ is important for investors as it gives them guidance regarding the quality of an Initial Public Offering (IPO). This means assessing the profitability of the issuing company, its management, and growth possibilities.
- Grading is based on both internal and external factors, such as operational efficiency and management competence.
- On a scale of 1 to 5, a strong company basis in analysis indicates low-risk. This way, during the IPO an investor can make a well-informed decision.
- The IPO grading does not consider the issue cost or market scenario. Thus, it should not be used for predicting share values, spotting frauds, or setting bid prices. It should instead provide an in-depth analysis rather than merely relying on ratings.
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Importance of IPO Grading
There are a few key reasons why IPO grading is important in finance:
- The concept of IPO grading is aimed at giving more insights regarding those firms that are private or have no historical performance records.
- The main objective is to provide investors assistance in assessing the IPO prior to making investment decisions.
- By providing investors with additional information, grading makes it possible for them to make well-informed decisions and indirectly assess what the fair value of the stock should be.
- To help the company to be in control of a premium for the IPO issue, stronger company fundamentals are required hence higher IPO grades.
What are the Factors Considered in IPO Grading?
IPO grading assesses both internal and external influences faced by issuing companies. Let’s discuss them in brief:
Internal Factors
These include management team capabilities, promoter profiles, company marketing strategies, competitive edges, growth perspectives, technology projects, and functioning efficacy. Moreover, monetary flexibility, property grade levels, accounting practices, and precautionary measures against sudden hazards are also considered.
External Factors
There are various factors involved such as larger industry background, market forces, and general business climate. The issue price does not contribute to the rating. Each subscriber must also examine the subscription on their own when investing.
What are the Grading Scales?
The grading range for an IPO denotes the quality of the fundamentals. The purpose of the assigned grade is to guide the investors’ choice regarding investing in the IPO stocks or not. A higher grade implies a brighter future of the company whereas a lower grade suggests increased risk in investments.
Here is the categorisation of each grade level and its meaning:
- Grade level 1 ‐ Poor fundamentals
- Grade level 2 ‐ Below average fundamentals
- Grade level 3 ‐ Average fundamentals
- Grade level 4 ‐ Above average fundamentals
- Grade level 5 ‐ Strong fundamentals
When Grading Should Not Be Used?
Grading is the best way to know a company’s basics. However, there are instances when you shouldn’t use it. Let’s understand these cases:
- In case referring to subscription in a company
- To forecast share prices at their entry point
- To identify the fraud or malpractice in a company
- For judging bidding prices
- Investors should not use it if they assume or consider SEBI has a crucial role in deciding the grade of an organisation.
Conclusion
IPO grading is significant for investors since it offers a better understanding of an IPO’s future growth before its release into the market. This includes considering internal and external factors that inform an investor’s decision and also show the firms fundamentals. Furthermore, it aids in evaluating IPO quality and defining expectations regarding share prices. However, investors must understand that the grade given does not have any relationship with offer prices or the current situation in stock markets. Therefore, understanding IPO grading enhances investing strategies among new public corporations making them safer options in terms of investment decisions made.
FAQs On IPO Grading
For grading an IPO, a company willing to go public must cover the expenses incurred.
The SEBI prescribed that firms should receive a score from a credit assessing agency for IPOs that were submitted on or after 1st May 2007. However, since 4th February 2014 grading of IPOs has been left optional for issuers.
No. The grading is an unbiased and independent process/decision made by a credit rating agency.
IPO grades cannot be rejected. ICDR (Issue of Capital and Disclosure Requirements) Regulations mandate that all grades must be revealed irrespective of the issuer’s acceptance. Moreover, documents provided by the issuer may include requests for a different grade but will contain all results.
The IPO grading is intended to match with the SEBI filing of offer documents together with observation issuance. As SEBI’s observations and grading are different entities, grading should not postpone the IPO process.