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Don't let ratings influence your IPO investment

Priya Nair/Mumbai 30 Nov 12 | 12:29 AM

With the first half of the year gone, both the government and companies are likely to raise money through the offer-for-sale or public offerings (both initial and follow-on) routes.

For retail investors, it could be an opportunity to enter stocks, especially if the shares are offered at a discount. The government has also made equity investing more attractive through the Rajiv Gandhi Equity Savings Scheme, which provides a nominal – Rs 5,000 – tax benefits.

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The question is how to decide the stocks. Ratings from agencies like Crisil and Icra could be one way. But there is a statutory warning. Use these gradings only as the starting point and look at other factors.

IPO grading looks at the liquidity of the stock, default by the company and few other hygiene factors. But a company whose IPO received a poor grading can perform well in the future because of the growth potential in that sector. Or conversely, it might happen that the IPO received a good grading, but because of a change in management, the company’s performance suffered later.

The performance of a stock is a function of demand and supply and there is no straight correlation between the IPO rating and stock performance.

Ratings are useful in the sense that they give some information and bring some standardisation. Otherwise, you might be comparing apples to oranges. But making your to investment decision solely based on the grading can be risky.

Even experts aren’t too convinced with ratings. Krishnamurthy Subramanian, assistant professor at the Indian School of Business, says, “I am not a big fan of IPO grading because there is no historical performance to go by. The same agencies that rate bond issues follow a well laid out methodology. But in the case of IPOs, there is a lot of uncertainty and more subjectivity."

So, the investor is left on his own. Or, he has to take advice from another expert. He needs to take the call depending on his risk appetite, investment horizon and so on. For instance, for a retired person, investing in an IPO is not advisable, no matter how highly it is graded.

According to Mohit Modi, director, equities, CRISIL Research, one of the rating agencies that grades IPOs, the grading is a comment on the fundamentals of the company (which are based on the historical audited balance sheets and likely payouts over the next two to three years), the attractiveness of the company in relation to the industry or sector it belongs to, the management’s capability and corporate governance practices. It is not a comment on the valuation of the IPO.

Incidentally, CARE Ratings, which is planning an IPO has asked for exemption from being graded, since it will mean opening up its balance sheet to its competitors. So, if you want to invest in CARE’s IPO, you may not have a grading to consider. Then you have to do your own due diligence.

In such a situation, it might be better to follow the same procedure for other IPOs as well.

Sensex

Company Price Gain (%)
Larsen & Toubro1,377.302.48
GAIL (India)384.201.48
B H E L189.301.42
Tata Steel426.601.32
M & M1,036.751.22

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