If the grading of public issues (IPOs) by leading rating agencies is anything to go by, then investors looking to invest in IPOs of companies with strong fundamentals do not have much choice. Only five issues in the last seven years have been graded as ?strong? in terms of company fundamentals.

According to data available with the National Stock Exchange (NSE), there have been nearly 160 issues since 2006 when the Securities and Exchange Board of India (Sebi) introduced the concept of IPO grading. Nearly 65% of these issues have been either graded ?below average? or ?average? by agencies like Crisil, Care, Icra, Fitch and Brickwork.

Interestingly, the coming week would see domestic search engine Just Dial launch its IPO to raise at least R820 crore. The issue has been graded 5/5 by Crisil, indicating strong fundamentals. This comes against the backdrop of an IPO of Scotts Garments, which was graded 3/5 by Care, being withdrawn due to poor investor response.

Rating agencies typically follow a grading scale between 1 (poor) and 5 (strong). According to the data, a total of 50 offerings have been assigned a grading of 2/5, indicating below average fundamentals, while another 54 IPOs received a grade of 3/5, which denotes average fundamentals. Further, there have been 14 IPOs with a grading of 1/5, which means the fundamentals of the company are poor.

Industry players have always been divided on the efficacy of the IPO grading mechanism ever since it was introduced in April 2006 on an optional basis and made mandatory in May 2007.

Investment bankers say that there is hardly any correlation between grading and the stock performance post-listing and so investors do not really gain from the added disclosure. Rating agencies, on their part, say that the grading process includes an assessment of business, financial prospects, management quality and corporate governance and they do not comment on the pricing.

?The debate on IPO grading has been on ever since it was introduced in 2006 and India still remains the only country where an equity offering is graded. There have been instances where a poorly graded IPO got a huge investor response and a highly rated one also saw subdued interest. I really don?t think investors have gained from this regulatory requirement,? says an investment banker with a foreign firm. .

Rating agencies, meanwhile, say that though the price is not taken into account, there is

evidence to prove that higher graded companies fare better.

?There are two major observations. One, the volatility in prices of better graded companies is much lower than fundamentally poor entities. Second, the quantum of fall in share price when compared to the issue price is lower in the case of higher graded companies,? says Care chief general manager Revati Kasture. Crisil declined to comment on the matter.

Grading system

* Sebi introduced IPO grading in 2006

* IPO grading made mandatory in May 2007

* Nearly 160 public offers since 2006

* Only five given highest 5/5 grading by agencies

* 65% of the issues either ?average? or ?below average?

* 14 issues received lowest ?poor? grading

* Bankers, rating agencies remain divided on efficacy of IPO grading