IPO valuation is the method through which a group of analysts calculate the appropriate value of the shares of a company. The value of a company's initial public offering (IPO) is the price attached to each share before it gets listed on the stock exchange. The company that decides to go public hires investment bankers who devote a significant amount of time and effort in determining its value.
Process of valuation of an IPO
Investment bankers are employed by the firm to assist them in analysing the company's financial factors. Company executives, along with them, carefully consider all parameters, including the company's revenue collection and its assets and liabilities before deciding on the quantity of shares to be issued and the price or price range at which they should be sold. After the approval from SEBI, a final ‘Red Herring' prospectus is issued and is listed with the stock exchange. Then the value of the IPO is determined.
Factors determining the value of an IPO
Certain factors such as the demand for the company’s shares play a role in the valuation. By and large, the following factors determine the IPO’s value:
- The current trends in the stock market
- The company's financial record in the past few years.
- The company's prospective growth rate
- The business model followed by the company
- Demand from potential consumers for the stocks
- The prevailing price of shares of the similar firms in the industry
- Number of shares to be issued
Approaches used while determining the value of an IPO
The process of valuation of an IPO is a demanding one and requires a systematic procedure to be followed. Generally two approaches are navigated while calculating the pricing of an IPO. These are absolute valuation approach and relative valuation approach.
1. Absolute valuation approach
The current value of a firm or organisation is estimated in an absolute valuation method by predicting future income sources via Discounted Cash Flow (DCF) analysis. This computation is accomplished with the help of the firm's financial statements and accounting records to determine the value of the company.The company's future cash flow is projected using DCF analysis, which then is discounted to the firm's present value to obtain the absolute value.
2. Relative valuation approach
The firm's value is compared to that of its industry competitors in a relative valuation approach in order to determine the company's financial potential. Here, the worth of the company is estimated using ratios, benchmarks and averages wherein the benchmarks can be adjudged by conducting a wide industry analysis. This method may also be used by investors to determine whether a stock is worth buying.
In a nutshell, while determining the price of an IPO, it is more important to consider the company's valuation rather than the price of a single share. The share price is impacted by a number of variables after it is listed, namely economic circumstances and overall market perception.The shift in the share price is then indicated by a comparable change in the company's valuation.
However , an IPO is similar to any other investment wherein investors are expected to do their analysis before committing any funds. A smart initial step is to go through the prospectus and financial statements. Getting influenced by the media coverage and rumours may not be a good idea.