IPO Gradings and Market Performance

Mr. Buffett had once said, a company might be a brilliant company, but a bad investment which I believe is very true. The fundamentals of the company might be pretty strong, the company might generate a loads of cahs, have high returns on invested capital, low debt on books and a leader in its field of operations. But that does not make it a good investment. The above criterias just satisfies one of the three things that Graham had mentioned, i.e. thorough analysis. The other two criteria, namely the adequate returns and safety of principal are both guaranteed by the valuations at which the stock is being offered.

And the IPO gradings only take care of the first criteria, they leave out the other two parameters on valuations. That is the sole reason why there cannot be a correlation between the investment performance and the company performance. The very act of coming out with an IPO is akin to a bride getting ready for the marriage, she would obviously dress herself in the best possible way after all she is the bride. Similar is the case with the owners who come out with an IPO, they would want the best value for their shares, would dress the IPO nicely, will promote with all the rigor. The valuations of IPOs are generally on the higher end.

For example consider the company Aster silicates, whose price went from somewhere to nowhere. It came out with an IPO price band of Rs.112-118, went on to reach a high of Rs.255 and presently trades at around Rs.48/share. At the offer price band and post issue equity, the company had and PE of 37.7-39.7. The company is a commodity space with no entry barriers, and neither did the company had high Returns to justify such a high PE. The valuation grading commented nothing on this, and it is not supposed to comment. The valuation part is something what the brokerages had to take care of and most of them did it correctly.

I would have been more surprised had the results of the study thrown some correlation, because then SEBI would have come out and said, IPOs with high gradings have performed well. This would have given further leeway to companies to come out with higher valuations as the subscribers to the issue would obviously have something at the back of their mind which would jingle like "High grading=high fundamentals=Good stock performance".

If sebi is so interested in correlations, would it not make more sense to do a correlation between IPO gradings, brokerage recommendations and the stock performance as it would capture the true definition of investment.

For the article that prompted this post refer the link below

Sebi study finds IPO grading futile
http://www.business-standard.com/india/news/sebi-study-finds-ipo-grading-futile/412080/