Higher IPO graded companies enjoy better valuation: CRISIL

For the period under review, these companies also weathered the business cycles (global financial turmoil in 2008-2009, followed by a slowdown during 2011-2012) better on the back of robust business fundamentals, superior management strength and good governance practices. Since all these parameters are taken into account in the IPO grading process, this finding is a reflection of the effectiveness of the grading methodology. CRISIL Research analysed the performance of these graded companies over a five-year period (May 2007 - June 2012) on the basis of valuation multiples (P/B and P/E).

IPO grades and valuation multiples: Correlation remains strong
CRISIL Research’s annual study on IPO grading reveals that companies with higher IPO grades command higher P/B and P/E multiples. This time, the study was carried out on a larger set of 179 companies for P/B analysis and 134 companies for P/E analysis.

IPO grades and P/B analysis
CRISIL Research’s analysis concludes that IPO grades assigned to companies and the P/B multiples at which they trade have a strong correlation.

The analysis highlights the premium assigned to companies with strong business fundamentals, superior management strength and governance
practices (key factors that determine a company’s IPO grade).

CRISIL Research observes that companies with an IPO grade of 5/5 (indicating strong fundamentals relative to other listed securities in India)
enjoyed a median P/B (price to latest book value of the company) of 3.79x vis-à-vis 0.33x and 0.45x for companies with IPO grades of 1/5 and 2/5,
respectively. Companies with IPO grades of 4/5 and 3/5 had P/B multiples of 1.49x and 1.00x, respectively. (Refer to Table 3 for grading
nomenclature).

IPO grades and P/E analysis
A similar analysis with P/E multiples also shows a strong correlation. Companies with an IPO grade of 5/5 enjoyed a median P/E (price to 12-month
trailing earnings per share) multiple of 15.7x vis-à-vis 8.3x for companies with an IPO grade of 2/5. Companies with IPO grades of 3/5 and 4/5 traded at median P/E multiples of 9.0x and 10.6x respectively (refer to Table 3 for grading nomenclature). However, the median P/E multiple of 12.7x for companies with IPO grade 1 was an exception as many companies reported extremely low EPS (earnings per share) thereby resulting in high P/E ratio (low EPS = high implied multiples).

Conclusion: The analysis confirms that there is a strong correlation between the IPO grades and the valuation multiples commanded by them. Higher IPO graded companies will most likely command higher multiples in the longer run as fundamentals will overrule the quintessential emotions of greed and fear.

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