- Date : 25/10/2022
- Read: 4 mins
Premium IPO Valuation is influenced by company growth prospects, industry and market conditions, IPO valuation methods used and the financial position of the company
With Adani Wilmar trading 210% over its listing price, and LIC trading 35% below its, investors are often left wondering – is there a perfect method of knowing the fair price of an offered stock?
Despite occasionally glaring listing price-offer price mismatches, Initial Public Offering (IPO) valuation is not a shot in the dark. A team of experts and analysts follow a clear process to arrive at the fair value of a company’s price. Apart from the financials of the company, various external factors including, but not limited to, market sentiments, company perception, industry outlook etc. influence the eventual performance of the stock in the market.
Also Read: Understand grey-market IPOs and why you should check grey market premium while applying IPOs
Factors That Matter in IPO Valuation
As an investor, there are various factors you can consider in checking if the Initial Public offering valuation is close to its probable trading and listing price, or not. IPO valuation components include,
Industry parallels – If the company applying for the listing is in an industry with listed players, the investor should compare the financials. The financials of the unlisted company as provided in the red herring prospectus, and the financials of the listed competitors as available in the public domain can make for a fair comparison. Apart from sales and expenses, assets and liabilities, the financial ratios can contribute towards an informed conclusion.
Market Trends – During the early 2000s IT boom, tech IPOs generated high demand. However, as the bubble burst, it became apparent that market sentiment cannot displace company performance as the fair IPO valuation parameter. Nevertheless, the market trend continues to sway IPO valuations during the recession as well as during surges.
Growth Prospects – The financial performance of the company, steadiness of income and profit, control over cost and liabilities, IPO proceeds utilisation plans etc. are reliable indicators of the company’s prospects for growth. A loss-making company with huge debts, minimal promoter holding, and an underwhelming utilisation plan would face a tepid response in IPO listing and valuation.
The Boston Consulting Group had done a definitive analysis of the factors that contribute to premium IPO valuations. It gives an insight to investors on how IPO price is decided by market forces.
Mid-size companies with an employee strength of industry average or below have traditionally enjoyed premium IPO valuations in the market. Companies with simpler organizational structures enjoy better valuation than companies with multiple divisions and complex organizational structures. Companies backed by venture capitalists have more premium valuations as it boosts investor confidence.
The study also observed that companies with strong revenue growth and above-average margins fare better. Low levels of debt financing and high expected dividend yield are other positives for premium IPO valuation. Similarly, high capex levels and cash usage ratio can encourage aid premium valuation.
Besides, read the company’s red herring prospectus to know all about the company, its financials, business projections, utilization plans, management team etc. to judge the fairness of the IPO valuation for yourself.
Also Read: IPO market expected heat further these 3 upcoming IPOs can continue to provide excitement
IPO Valuation Methods
It is important to go through the different valuation methods to understand what is IPO valuation in the first place.
- The Relative Valuation method considers the comparables in the industry i.e., valuation numbers of companies from the same or similar industry that are listed on the stock exchange.
- The Absolute Valuation method uses discounted cash flow and measures the financial strength and position of the company.
- Discounted cash-based valuation is more elaborate as a method. It considers the projected revenue sources and cash flows, investments, forecasted performance and other projections.
- Economic valuation uses set parameters to conduct a mathematical valuation, including the business income and residual income, debts outstanding, assets and liabilities, business risks and so on.
- Price to Earnings Multiple Valuation uses the comparison between the annual income and market capitalisation of the company. The ratio of stock price to earnings per stock is a popular valuation metric for listed stocks as well.
Thus, it can be concluded that IPO is more about the valuation of the company rather than the valuation of the share itself. Once listed, the share price is influenced by various external factors as well, like market sentiment, economy, geopolitical scenario, government policies etc.
Ensuring that the IPO gets a premium valuation is a challenge for the analysts involved. Similarly, identifying IPO investments with the prospect of premium valuations is a challenge for investors. As an investor, you can analyse a company based on the aforesaid factors to give your best foot forward while investing in Initial Public Offerings.
Also Read: IPO exit strategies optimise your gains
With Adani Wilmar trading 210% over its listing price, and LIC trading 35% below its, investors are often left wondering – is there a perfect method of knowing the fair price of an offered stock?
Despite occasionally glaring listing price-offer price mismatches, Initial Public Offering (IPO) valuation is not a shot in the dark. A team of experts and analysts follow a clear process to arrive at the fair value of a company’s price. Apart from the financials of the company, various external factors including, but not limited to, market sentiments, company perception, industry outlook etc. influence the eventual performance of the stock in the market.
Also Read: Understand grey-market IPOs and why you should check grey market premium while applying IPOs
Factors That Matter in IPO Valuation
As an investor, there are various factors you can consider in checking if the Initial Public offering valuation is close to its probable trading and listing price, or not. IPO valuation components include,
Industry parallels – If the company applying for the listing is in an industry with listed players, the investor should compare the financials. The financials of the unlisted company as provided in the red herring prospectus, and the financials of the listed competitors as available in the public domain can make for a fair comparison. Apart from sales and expenses, assets and liabilities, the financial ratios can contribute towards an informed conclusion.
Market Trends – During the early 2000s IT boom, tech IPOs generated high demand. However, as the bubble burst, it became apparent that market sentiment cannot displace company performance as the fair IPO valuation parameter. Nevertheless, the market trend continues to sway IPO valuations during the recession as well as during surges.
Growth Prospects – The financial performance of the company, steadiness of income and profit, control over cost and liabilities, IPO proceeds utilisation plans etc. are reliable indicators of the company’s prospects for growth. A loss-making company with huge debts, minimal promoter holding, and an underwhelming utilisation plan would face a tepid response in IPO listing and valuation.
The Boston Consulting Group had done a definitive analysis of the factors that contribute to premium IPO valuations. It gives an insight to investors on how IPO price is decided by market forces.
Mid-size companies with an employee strength of industry average or below have traditionally enjoyed premium IPO valuations in the market. Companies with simpler organizational structures enjoy better valuation than companies with multiple divisions and complex organizational structures. Companies backed by venture capitalists have more premium valuations as it boosts investor confidence.
The study also observed that companies with strong revenue growth and above-average margins fare better. Low levels of debt financing and high expected dividend yield are other positives for premium IPO valuation. Similarly, high capex levels and cash usage ratio can encourage aid premium valuation.
Besides, read the company’s red herring prospectus to know all about the company, its financials, business projections, utilization plans, management team etc. to judge the fairness of the IPO valuation for yourself.
Also Read: IPO market expected heat further these 3 upcoming IPOs can continue to provide excitement
IPO Valuation Methods
It is important to go through the different valuation methods to understand what is IPO valuation in the first place.
- The Relative Valuation method considers the comparables in the industry i.e., valuation numbers of companies from the same or similar industry that are listed on the stock exchange.
- The Absolute Valuation method uses discounted cash flow and measures the financial strength and position of the company.
- Discounted cash-based valuation is more elaborate as a method. It considers the projected revenue sources and cash flows, investments, forecasted performance and other projections.
- Economic valuation uses set parameters to conduct a mathematical valuation, including the business income and residual income, debts outstanding, assets and liabilities, business risks and so on.
- Price to Earnings Multiple Valuation uses the comparison between the annual income and market capitalisation of the company. The ratio of stock price to earnings per stock is a popular valuation metric for listed stocks as well.
Thus, it can be concluded that IPO is more about the valuation of the company rather than the valuation of the share itself. Once listed, the share price is influenced by various external factors as well, like market sentiment, economy, geopolitical scenario, government policies etc.
Ensuring that the IPO gets a premium valuation is a challenge for the analysts involved. Similarly, identifying IPO investments with the prospect of premium valuations is a challenge for investors. As an investor, you can analyse a company based on the aforesaid factors to give your best foot forward while investing in Initial Public Offerings.
Also Read: IPO exit strategies optimise your gains
