IPO Grading
Investing in Initial Public Offerings can be rewarding as well as a risky affair. Considering the risk factor, SEBI introduced an IPO grading in India.
IPO grading is a process through which grades are assigned to companies' initial offerings based on certain factors. The closer the grading to 5, the stronger the company's fundamentals.
As per SEBI, IPO grading can be done before or after filing documents (draft offer).
In this blog, we are going to cover the following:
- What is IPO grading?
- Working of IPO grading
- Factors influencing IPO grading
- Importance of IPO grading
What is IPO grading?
It is a procedure through which specific grades (level 1 to level 5) are assigned to the IPOs launching in India. Grading is done by Credit Rating Agencies (CRAs) tied up with SEBI (Securities and Exchange Board of India).
A grade aids in comparing one IPO with other IPOs listed on the stock exchange. The comparison is made based on two major factors, i.e. company fundamentals and market conditions.
Grading of IPOs is done on a scale of 5. Higher the number, the better the company's fundamentals. Similarly, the lower the number, the weaker the fundamentals.
As per ICDR regulations, whether a company is in favour of the grading assigned to them or not, they are obliged to disclose it. Companies must accept grades given to them. However, they can choose to get grades from different agencies if they are unsatisfied.
Working on IPO grading
SEBI has made it compulsory for companies to get a rating done with one of the credit rating agencies. It was required for companies filing for IPOs after 1 May 2007. Though after 4 February 2014, IPO grading has been made optional for the issuer.
Based on the company's fundamentals, the grades are given on a 5-point scale. These are as follows:
- IPO Grade 1 = Poor company fundamentals
- IPOGrade 2 = Below-average company fundamentals
- IPO Grade 3 = Average company fundamentals
- IPO Grade 4 = Above-average company fundamentals
- IPO Grade 5 = Good/strong company fundamentals
The rating given to companies by CRAs depends on numerous factors. Let's discuss them.
Factors affecting IPO grading
IPO grading depends on numerous factors. Industries in which a company operates, its financial position, its strengths and its competitive advantage are a few among others.
The following factors affect a company IPO's grading (though not limited to these factors):
- Financial positions of the company
- Capabilities of management
- Industry prospects of a company
- Company prospects
- Competitive advantage
- Corporate governance practices
- Risks and opportunities of new projects
- Company's business environment
These are only a few of the other factors considered while assigning grades to the IPOs of the companies. These factors may vary by company and industry-wise.
SEBI made an effort to facilitate the decision-making process of investors by making available additional information about the firm's fundamentals.
Importance of IPO grading
If SEBI has made it mandatory for companies to get themselves graded by rating agencies, it must have a solid reason behind it.
Investors can use grades given by credit rating agencies to make informed and wise investing decisions. Various factors, such as growth prospects, financial position, competitive advantage, etc., can aid investors in investing decisions.
As an investor, you can find these grades (with description) in the following places:
- Prospectus
- Abridged prospectus
- Advertisement places of a company
One can find detailed descriptions or reasons behind assigning a certain grade in the Grading letter given by the credit rating agency at the company's registered office.
However, SEBI has warned investors to make independent decisions about whether to invest only after considering all the aspects of a company.
When shouldn't grading be used?
Grading is a decent way to enlighten yourself on a company's fundamentals. Here are some of the cases when one should not use it:
- When recommending to subscribe to a company's offering
- To make a forecast about the listing prices of the shares
- To detect fraud or malpractices in a company
- To make a judgement about the bidding price
- To assume that SEBI has a crucial role in deciding the grade of the firm
Final words
To facilitate the decision-making process of investors interested in the primary market, SEBI launched the grading of IPOs.
Based on various internal and external factors, grades (levels one to five) are assigned to the initial offerings. These grades aid in comparing them with those listed in the stock exchanges at the time of issue.
Though these are a good indicator of how strong a company's fundamentals are, SEBI has suggested that investors consider other factors, such as risk factors, while making decisions.
After 4 February 2014, SEBI made it optional for companies to get their primary offers graded.
As an investor, you can find these grades on different prospectuses and advertising places of a company.
Frequently Asked Questions
Who has to bear the cost of grading?
The issuer company has to bear all the expenses related to grading done by credit rating agencies.
Is grading mandatory?
No. After 2014, IPO grading was made optional by SEBI.
Does SEBI play an important role in the IPO grading process?
No. The grading is an unbiased and independent process/decision made by a credit rating agency.
Can the issuer reject the grading?
No. Grading has to be disclosed. However, if unsatisfied, the company can hire a different agency for different grading.