Equity Valuation for IPO: Hot and Cold Market Anomaly

This dissertation explores the equity valuation for IPOs in hot and cold market periods. It discusses the impact of underwriter reputation, valuation methods, and the performance of IPOs after launching in the secondary market. The study aims to identify factors affecting IPO performance and provide insights for academic and business perspectives, particularly for Hong Kong firms.

DISSERTATION

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................3
Background of research topic......................................................................................................3
Development of theories .............................................................................................................4
Why topic is important................................................................................................................4
Research question........................................................................................................................4
Research objectives......................................................................................................................5
Structure of project......................................................................................................................5
CHAPTER 2: LITERAGTURE REVIEW......................................................................................6
CHAPTER 3: RESEARCH METHODOLOGY...........................................................................17
Research introduction................................................................................................................17
Research type.............................................................................................................................18
Research approach.....................................................................................................................18
Research design.........................................................................................................................19
Research philosophy..................................................................................................................19
Data collection...........................................................................................................................20
Data analysis..............................................................................................................................21
Ethics.........................................................................................................................................21
Validity and reliability...............................................................................................................22
Research limitation....................................................................................................................23
CHAPTER 4: DATA ANALYSIS................................................................................................24
Transcription..............................................................................................................................24
REFERENCES..............................................................................................................................27
APPENDIX....................................................................................................................................29

INTRODUCTION
Background of research topic
Equity is one of the major source of finance for the firms specially for those who intends
to carry out large size projects. Every year number of firms raised huge amount of capital
through equity. In order to issue shares in the market firms needs to launch IPO in primary
market. There are number of theoires and techniques that are taken in to consideration for IPO
valuation. Usually, firms takes an assistance from the investment banker for determining price of
shares that will be issued during IPO process. It can be said that equity is one major source of
finance for the firms. Equity valuation is one of the complex topic and lots of discusion is
carried out on same. In past time period many researches are conducted in respect to hot and
cold market period. In these researches it is identified that during hot market higher percentage
of return is gained. Whereas, during cold market time period low return is gained. In research
industries stocks were taken that are cyclical, defensive, growth and sensitive in nature. In case
of cyclical IPO it was observed that market average rate of return was 47% in hot market but
same was 3.5% in cold market. This return is related to first day when IPO was launched. In case
of first week criteria of comparison it is identified that in cold market period return of 8.5% and
same in case of hot market period was 48.1%. In case of first month time period in case cyclical
stock it is identified that in hot market there is return of 58% and same in case of cold market is -
0.1%. So, it is clear from facts and figures that in case of hot market very huge amount of return
is earned but in case of cold market very low rate of return is made. Thus, it can be said that
there are some factors which lead to earning of less amount of return in cold market and high
return in hot market. In the current research study hot and cold market related information will
be taken in to consideration for IPO valuation purpose.
In the current report IPO valuation is done and in this regard PE ratio method is used.
This is because it is considered as one of the most important method for equity valuation. Under
PE ratio it is identified whether shares are undervalued or overvalued. In this regard usually firm
price earning ratio is compared to industry PE ratio and on this basis it is identified whether
shares are undervalued or overvalued. In current research study also price earning ratio method is
used for equity valuation. In this regard secondary data will be gathered and firm price earning
ratio will be computed. Similalry, industry price earning ratio will also be computed and in this
regard relevant firm peer companies price earning ratio will be taken in to account and same will
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be used to measure value of price earning ratio of industry. Thus, it is one of more balanced
approach because in same industry and company PE ratio is compared and on basis of
comparison it is identified whether shares are overvalued or undervalued. Apart from this,
qulitative analysis will also be done in the report along with quantitative analysis. In this regard
interview of experts will be taken and on basis of same it will be identified whether during cold
season or hot season issue of IPO remain successful.
Development of theories
In the present research study relevant theories in respect to IPO valuation and relevant
areas will be discussed in detail in literature review section. In this regard hot and cold market
theory as well as underwriter hypothesis theory will be discussed in detail.
Why topic is important Academically: Academically this theory is important because this research report will
help academicicans in understanding the factors that play big role in making any IPO
successful or failed. Scholars and researchers will benefit a lot from present research
study. In terms of business perspective: Business firms will come to know about timing when
they must launch IPO in the market. Timing factor play a very important role in making
any IPO successful or failed and in current research study it will be identified that when
IPO must be launched in the market. Hence, due to this reason current research study will
prove helpful for individuals.
 In respect to Hong Kong business firms: This research study is very beenficial for Hong
Kong business firms. This is because in present research study only Hong Kong related
firm will be considered. Conditions may very from country to country but within nation it
remain same. Hence, in respect to Hong Kong business firms research study will be
relevant because mentioned nation firm is taken in to account in present reseearch study.
Research question
 What is the impact of underwriter reputation on performance of IPO?
 Which of valuation method is appropriate?
 What was the valuation of IPO at time of issue and their performance after launching in
secondary market?
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Research objectives
Resarch aim To identify factors affecting IPO performance.
Resarch objetives
 To find out impact of underwriter reputation on performance of IPO.
 To access different IPO valuation models and their effectiveness.
 To explore valuation of IPO at time of issue and their performance after launching in
secondary market.
Structure of project Introduction: In this seciton of the report detail information about project will be given.
Approaches that will be used in present research study is determined and along with this
different aspects of research study are discusseed in detail. Literature review: In this section of the report different aspects of the research study is
disucssed in detail. Views of different authors will be critically reviewed in detail. Thus,
it is one of the most important part of research study. Research methdology: In this section of the report approaches and techniques that will be
followed for conducting present research study will be discussed. This is the one of the
most important part of research because in this way in which research will be carried out
will be outlined. Data analysis: In this section of the report facts and figures will be analyzed in detail.
Secondary data will be gathered in present research study and same will be analyzed by
using price earning ratio method. It can be said that it is the part on the basis of which
other sections will be prepared.
 Discussion, Conclusion and recommendation section: In this section of the report data
analyzed will be discussed in detail and reveiwed and this will lead to development of
conbclusion and recommendation seciton of report.
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CHAPTER 2: LITERAGTURE REVIEW
Literature review
Rock (1986) developed a popular model for the theoretical analysis of the underprice of IPO. It
suggests that information asymmetry of market participants causes underpricing. Regarding to a
part of market participants and investors possessing superior information, Rock believes that
investors are classified into two types: informed investors and uninformed investors.
Informed investors are given more information while list uninformed investors are given higher
probability of having bad IPO information. Also, the former ones compete for good IPOs with
the latter. This results in an adverse selection mechanism. Oversubscriptions for those good IPOs
are to be seen while there is an excess supply for the bad IPOs. Since there is an oversubscription
of the good IPO, the shares of the IPO are allocated through rationing. Informed investors are
able to differentiate the quality of the IPO at an early stage. Therefore they are able to subscribe
the IPO they wanted. On the contrary, uninformed investors receive disproportionate levels of
bad IPO.
In conclusion, this is called the Winner Curse. According to Rock, in order to induce uninformed
investors to participate, issuers have to underprice their IPOs.
1.1.1 The underwriter reputation hypothesis
In the following part, I am going to introduce Baron’s (1982) underwriter reputation hypothesis.
This hypothesis stands with Rock’s assumption of asymmetric information but on top of it,
Baron suggests this assumption exists among market participants and investment bankers only.
The reason that Baron believes that the asymmetric information happens among market
participants and investment bankers is that they have superior information to that of the issuers
and investors. What he focuses on is the optimal behavior of issuers as the principals and at the
same time investment bankers as the agent in executing the IPO. Baron’s model not only
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explains how new issues are underpriced but also demonstrates a positive demand for investment
bank advice and distribution service. Although the model provides contribution to the
underwriter reputation model, there are no empirical evidence to support the proposition as it
does not consider the role of underwriter reputation.
Logue(1973) proposes that there is a negative relation between the underwriter reputation and
the degree of underpricing basing on 250 US IPOs from 1965-1969. His research is about the
effect of the underwriter reputation of IPO performance.
Beatty and Ritter (1986) suggest that investment bankers promoted the underpricing equilibrium.
They believe that issuers are not able to make credible commitment on their own. Investment
bankers should be hired to assist the company to make public offering. This creates a role for
investment bankers in the underpricing equilibrium.
There are three necessary conditions for an investment bank to enforce the underpricing
equilibrium.
First, investment bankers are uncertain about the market price of the IPO after listing. Also, they
can earn a return based on their non-salvage reputation. As investment bankers are prone to lose
their earning, should they not risk by cheating underpricing too large or too little. The literature
suggests the last two conditions are the standard conditions on reputation and product.
According to Beatty and Ritter (1986), investment bankers should be willing to not to behave
opportunistically in order not to put their good reputation at stake. The literature proposes that if
an investment banker cheats, he shall lose his clients, issuers and investors.
It is called pricing ‘off-line’ when underwriters have a larger average residual than standard. In
opposite, underwriters that have less average residual, are called nonprestigious underwriters and
known as pricing ‘on-line’. Beatty and Ritter tested the hypothesis through using the
underwriter’s standardized average residual to measure the reputation. They also looked into the
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changes of the market share of the underwriters following the IPOs. There are empirical
evidence showing the strong support for the proposition.
Studies appear after the appearance of what Beatty and Ritter did. There are reports showing that
there is a negative relationship between the prestige of investment bankers and underpricing. As
in other words, the more prestigious the underwriters are, the underpricing is in a lower degree.
Johnson and Miller(1988) extended their study through suggesting another hypothesis. They
propose that when the ex ante uncertainty is taken into consideration, the prestige of the
investment banker ought not to offer incremental explanation of the degree of underpricing. I
will come back to the methodological of Johnson and Miller later in the essay.
All in all , the underwriter hypothesis propose that the role of investment bankers poses a
significant effect on the underpricing equilibrium. The more prestigious the underwrite, the less
degree of underpricing. Therefore, ‘good’ firms tend to recruit more prestigious underwriter so
as to show their position to investors while prestigious investment bankers lean to select ‘good’
issuers to be sent into the market.
1.2 Hot/Cold market anomaly
The Hot/Cold market anomaly is talking about the related market issue. Ibbotson and Jaffe
(1975) discovered this phenomenon in the US. Not only they saw the hot/cold issues in the
market, they also looked into the relationship between the performance of the new issues in the
certain calendar month and so as the previous month. It shows that at the starting month carries
strong serial dependency. This indicates that the hot issue market is predictable. Investment
bankers often suggest clients to go public during the hot market situation. However, Ibbotson and
Jaffe aimed to maximize the amount of money in hands. Therefore, they both agreed that listing
public during the cold market would be better than the opposite. Investors ought to avoid the
IPOs which follows the cold market and focus on their investment during those months. This
results in bring the greatest premia.
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The study also looked into the relationship among the amount of offerings and IPO returns. They
assumed the level of past returns to be linked to the number of offerings. The insignificant
regressions coefficient is caused by the regression model. As a result, the timing of new issue
offering is not related to the first month performance of the IPO after published.
Their study also shows that there are no relationship between the past market performance and
the new issue returns. The market index cannot be used as a guidance to issuers to select a month
to offer their issues.
Ibbotsib et al. (1994) further extended the study through enlonging the period of study. The
evidence matches the previous study. Ritter tried to use Rock’s implication to further explain the
hot issue. He suggests that the explanation of time series correlation of initial returns can be
shown through the correlation of risk composition of firms going public. This results in a higher
proportion of risky firms going into the market in the given amount of time. The other
explanation lies on the irration of the part of the investors other than the issuers and advisers.
There are times that hot issue markets can emerge when investors are exposed to new issues. At
this time, investors are assumed to be willing to accept a higher price for earnings and market to
book for new issues. As a result, firms go into the market to harvest the receptiveness and get a
better price for their share of offer. According to Byrne and Rees(1994), the optimism of
investors results in aftermarket prices being bid above intrinsic values and high initial returns are
seen.
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1.3 Equity Valuation
Models of equity valuation in the fields of finance literature are normally based on Miller and
Modigliani (1961). Miller and Modigliani (MM) state that the market value of a company
common equity is equal to the discounted value for present and future earnings. After MM's
model, the issue of equity valuation is being more important regarding to academia and practice.
Most of finance textbooks discuss some models for valuation, for example, the comparable firm
approach, the discounted cash flow (DCF) approach, and the asset-based approach (Benninga
and Sarig, 1997). The comparable firm approach implement capitalizing earning per share (EPS)
of the company under consideration at the average or median price earnings (P/E) ratio in
comparable firms. The DCF approach is kind of based on the MM model, which uses the future
cash flow and applies discount rate to the market value of a company. The asset-based approach
is going to look at the underlying value of the company's assets to determine the value.
1.3.1 IPO valuation
Because of not much available information in the market before listing, the DCF methods are
relatively not very useful. Normally, the prospectuses only disclose 3 years of financial reports
that is not enough for forecasts of appropriate future cash flow. Moreover, IPO companies may
be typically young but with high future growth rate, which will be more difficult to determine the
suitable discount rate.
Moreover, the other valuation method is the comparable company methods. According to
McCarthy (1999), it is the very common method to issuers and sponsors to set IPO offer price.
Kim and Ritter also state the usefulness of this method to valuation of IPOs. First of all, they use
price-earnings ratios (PE Ratio) as a denominator to an IPO market price. This result is poor
when using historical accounting numbers. But, the accuracy of IPO valuation will improve
much better when using forecast earnings. Additionally, they test other multiples, for example,
the market-to-book, enterprise value-to-sales and others. They find that these multiples somehow
are more accurate than using historical accounting.
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Closely relating about previous Kaplan and Ruback's study (1995), Berkam et al. (2000) test the
accuracy of the comparable firm multiples methods and the DCF methods for valuation of IPOs.
Based on set of data from New Zealand Stock' Exchange, they use forecasted or expected
accounting information to both methods. Not surprisingly in accordance with Kaplan & Ruback
(1995), they find that both methods also have similar accuracy of valuation of IPOs. But, the
result is highly depended on the used benchmark. They find that market-based benchmark used
can make more accurate estimation than using the industry-based benchmark.
As previously discussed. The signaling hypothesis is quite significant in the IPO theory. Downes
and Heinkel (1982) looked into the valuation of new equity offerings which is related to indicate
the firm value. They used the US IPO data from 1965-1969 to test the Leland-Pyle Model
(1977). They discovered that firms with higher fractional ownership tend to have higher values
the old shareholders believes in the firms' future value as signaled bt the ownership retention. As
a result, the old share holders tend to retain a high fraction of shares at the IPO. Therefore, the
relationship between the ownership retention at the IPO and the value of a firm is foreseen to be
positive. As mentioned in the underpricing section, There is an implication on the owners of the
good firms is going to retain a high fraction of the ownership at the IPO based on the signaling
model. It argues that underpricing is used by the management in order to signal the firm's true
value Therefore it is expected to gain a higher price at the subsequent seasoned equity offer.
Hence, old shareholders ought to get a high fraction of shares so as to offset the cost of
underpricing at the SEOs. According to Leland and Pyle's (1977) model, Krinsky and Rottenberg
(1989) thinks that the net proceeds which was indicated in the offering prospectus, can convey
the insiders' private information regarding the future planned -projects in the firms. As a result, it
is recognized as a signal to the firm value. Krisnky and Rottenberg (1989) discovered positive
relationships between the proceeds and the IPO (subscription and market) prices. Based on the
UK USM data, also Short and Keasey (1997) finds a support for the positive net proceeds firm-
value relationship.
There are other variables are used as signals to indicate the value of IPO. For instance, the
auditor quality (Beatty, 1989; Datar et al., 1991; Feltham et al., 1991), and the quality of
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investment banker (Titman and Trueman, 1986), and the relationship between the issuers and the
banks (Slovin and Young, 1990). The firm's accounting information, such as the earnings
forecast are used to value the issue (Kim and Ritter, 1999; Firth and Liau-Tan, 1998; Keasey and
McGuinness, 1991). Heinkel (1982), Ritter (1984), and Clarkson et A. (1991) use financial
information to control sample heterogeneity Kim et al.. (1995) focus on the value relevance and
so as the predictive ability of the information of Korean IPOs. Two regression models are thus
developed. The first one is based on the pricing –formulae which is prepared by the Korean
authority This pricing formulae was heavily dependent on future earnings, net asset value after
the offerings and industry characteristics. The second one is called the augmented model. This is
an expansion of the first model. It is created through incorporating three signal variables-
ownership retention, underwriters' quality, and investment level. Empirical results indicate that
there is a positive and important relationship between earnings and industry characteristic, and
the market price. Moreover, there are indications on variables which tend to have a significant
role in the explanation and prediction of the aftermarket price. However, there are no evidence
to show if there are any notifiable relationship between the potential signals and market price.
How and Yeo (2001) argue that earnings and dividends disclosure minimize the IPO information
asymmetry as they investigated how earnings and dividend forecast would affect the pricing of
Australian IPOs. After that, they assume that earnings and dividend forecasts disclosure is
related to IPO initial valuation. Be that as it may, there are no empirical evidence so support such
hypothesis. They implied Brown et al. 's (2000) study on Australian non- IPO cases and
discovered that earnings forecasts are subjected to error as noisy estimation of future cash flows
are seen. They then questioned the relevance of the forecast information throughout the valuation
process.
Firth (1998) took a look at the role of profit forecast in the prospectus as a signal' of IPO value.
His previous study (Firth et al.., 1995) shows that historical earnings are poor prediction
indicators of future earnings since there is a typically fast growth of IPO firms. There are no
incorporation of the effects of the expanded activities of the firm financed by the new issue
proceeds. By using the predicted earnings disclosed in the prospectus, Firth’s study discovered a
strong positive relationship between earning forecasts and IPO market valuation. This result
matches with Clarkson et A.’s (1992), data collected in Canada. Klein (1996) investigates the
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relation between the information provided to the prospectus and the pricing of IPOs. It’s
investigation is to examine whether investors could use the prospectus to give price to an IPO.
According to Modigliani-Miller (1966), the equity value is a linear function for accounting
earnings, book value of equity, expected earning growth, and market or firm specific risk factors.
Furthermore, the hypothesis suggests the IPO price is an increasing function of earning per share,
book value, expected growth while acts as a decreasing function of risk at the same time.
Through getting the pre-IPO accounting information, some accounting information is disclosed
in the prospectus. These are greatly relevant tothe offer and one-week prices. This may differ
from Kim and Ritter (1999). Klein finds that there is an important relationship between the offer
and one- week prices, and the percentage of equity retained the underwriter reputation, and if the
offer includes a warrant. Moreover, there are prospectus information that explains there is more
variation of the offer price the one-week price. This means that when after traded one week in
the market, information revealing is also taken into consideration in assessing the newly listed
firms. The literature and studies provided above show-case the importance of earnings forecast
information on the IPO pricings. DuCharme et al. (2001) argue that as there is a small amount of
information about the firm available for pre-IPO, incentive is proposed for issuers to manipulate
the reported earnings. Therefore, they think pre-IPO earnings managed by issuers are positively
linked to the initial firm value. When earning management is an unobservable variable, a number
of management of accruals are used as proxies. The study used 171 public US IPOs from 1982-
1997to look for evidence that can support the hypothesis of the positive relationship between the
earnings management and the IPO offer price. The result indicates that the issuers, report better
earnings forecasts, as well as having a high initial price in the market.
Regarding to the relationship of earning management and performance of IPOs, DuCharme et al.
(2001) tested one more assumption in the second part of their study. They believe that there is a
negative relationship between the pre-IPO earnings management and IPO returns in the after-
market. After the study, they found no evidence to show the relationship, thus the hypothesis
does not stand.
There is an investigation done by Beatty et al. (2002)on the IPO pricing based on accounting
information. It is focused on the explanatory power of revenue, accounting earnings, and book
value as cash flow surrogates, to the offer price, the filing price, and the initial market price.
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Several models are tested changes in models are found which produces differences in the
explanatory power . As they sum up, the model is more important with IPOs that with the
established firms.
Moreover, they developed three more general models in their study. The first is the offer price
against the accounting information. 5 proxies are used for the offer price (unscaled per share,
unscaled total value, total value scaled by book value, total value scaled by revenue, and natural
log of total value). Pre-IPO earnings per share and pre-IPO book value per share are used as the
predictors. There are results showing that there is a positive relationship among the earnings and
book valuewith all offer price proxies. Also the explanatory power of the model can vary among
the different offer price proxies. The study shows that the earnings and book value are able to
explain as much as 17.6 % to the variation of per share data and the highest at 65.9% on the
natural log model. In conclusion, the historical accounting information is able to provide
information that can explain the variability of the offer price.
The use of the natural log of total value can expand the model by a number of predictors (eg.
revenue, IPO year dummy, shares percentage retained at the IPO, and the residual from the
previous natural long model). The earnings and book value data are transformed to the natural
log form. All predictors are significant and of expected signs, and the explanatory power rises to
75.05%.
Through adding pre-IPO market return and the natural log of the filing price as new predictors,
the model above can then be expanded. This creates an impact to the explanatory power of the
model which is raised up to 98.18%. The earnings, book value, and retained ownership
coefficients then became negative and their significance is diminished. The result suggests that
underwriters tend to overweigh the importance the fundamental variables when setting the filing
price because the filing value captures what the offer price would be as assumed by the
underwriters.
The market value model will be explained in this part. The model is related to the initial market
price and the accounting information and control variables. Evidence shows that there is a
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negative relationship between the three fundamentals and the market price. The result indicates
that there is a smaller degree of underpricing with firms with high fundamentals when compared
to those with weaker fundamentals. The study develop a proxy for the ex-ante risk measure in
order to see if the lower market price can lead to risk adjustment. The standard deviation of the
after market returns for 1 year is discovered as an unbiased proxy to the ex-ante risk measure.
They took cross sectional analysis to test the impact of the accounting information, risk, size and
industry on the initial returns. Also, the model also consists of the offer value residuals to
investigate the partial adjustments. As a result, the study found out that there is a relationship
between accounting information and the initial returns. There is also a positive relationship
between the risk and the initial returns. This confirms the partial adjustment created by the
underwriters during the marketing period.
To sum up, there are several equity valuation models applied in the literature. Since there is very
little information about the firm available to the market in prior to the admission, choices are
limited when they apply it to the IPOs. It is regarded as the most comprehensive information
about the issuing firms. In other words, it is available prior to the IPOs. Klein (1996) investigates
if the prospectus information on the IPO pricing is useful by using the US data. This study
examines the impact of the prospectus information on the IPO offer price and market price. They
defined the prospectus information as the firm accounting fundamentals, the ex-ante risk factors,
and the signals. The basic model used is able to analyses the impact of the accounting
fundamentals of the firm on IPO prices. Which is known as the accounting-based valuation
model. The research model is expanded by including the risk factors and the signals through
following the studies which are previously done (e.g. Beatty and ritter, 1986; Krinsky and
Rottenberg,1989).
According to Bruton and et.al., (2010) underwriter reputation and IPO performance are
closely related to each other. This is because in IPO majority of investment is made by
institutional investors. These sort of investors always focus on underwriters because entire
valuation of equity is done by underwriters. Many times if their performance is not so good then
they issue shares at very low price in order to ensure that relevant amount of money will be
raised from IPO. Hence, in such kind of situation investors think that it will not be right to make
investment in the firm and IPO failed to give good performance in stock market.
Contrary to this Dong, Michel and Pandes, (2011) state that underwriter reputation and
IPO performnace are not very closely related to each other. Means that underwriter image only to
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some extent can affect IPO performance. This is because invesrors while making invesment in
any business firm give main priority to firm business performance and its portfolio. Whatever is
share price it does not matter for them. On this basis it can be said that underwriter image or its
reputation may not largely affect IPO performance. In researches it is already observed that
while making investment in any IPO investors always try to find out whether firm business have
required potential. If there is enough potential in business firm investors make heavy investment
in the company and that investment remain long term. Thus, it can be said that there is big
contact between underwriter reputationn and IPO performance.
According to Chan, (2010) hot and cold winter seasons and IPO performance are inter
linked to each other as it can be seen that during hot season good amount of return is genderated
by IPO then cold season. It is hard task to identify reason behind such trend by it is observed that
common tendency is there among people that during hot season IPO perform well and during
cold season they failed to give expected level of performance. This is the reason due to which
most of investors are making investment in those IPO that launched during hot season.
Contrary to this Lee, Kuo and Yen, (2011) state that hot and cold winter seasons does not
have any sort of impact on IPO performance. This is because IPO performance depends on
several factors. Existence of hot and cold winter does not have any impact. If across the world
observation will be done then it can be identified that investors consider lots of factor and on that
basis they make investment. They does not believe in fact that if season is hot then IPO will
perform well and if same is cold then IPO will not perform good. It depends that what is unique
selling proposition of the business firm. More market have positive sentiments and company
have strong USP IPO will perform better. Usually, it can be observed that when any firm bring
IPO in the market commentry going on news channels about IPO and potential that company
have to give return to the investors. IPO perform well if analysts believed that firm stocks have
huge business potential. This is because these analysts do positive word of mouth marketing of
the business firm and create positive sentiments about it among people. This promote investors
to make investment in the business firm and IPO become successful. Hence, thinking that during
hot season IPO perform well is not completely correct. In specific nation coincidently there may
be a trend where IPO become successful in hot seaosn then cold season but it does not mean that
investors always consider these seasonal factors while making investment in any IPO. Thus,
firms must focus on marketing of their strong factors for making IPO successful then seasonal
factors.
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CHAPTER 3: RESEARCH METHODOLOGY
Research introduction
Present research study is carried out on IPO valuation and identifying factors that affect
IPO performance. There are number of factord that have impact on IPO performance after issue
and its valuation. It is often important for investors to identify whether IPO in which they intend
to make purchase is overvalued or undervalaued in nature. If IPO is overvalued then investor
may decide not to make investment in firm shares. In the current research study focus is made on
IPO valuation method PE ratio and hot as well as cold season impact on share price. It is
identified that during hot season price of IPO valuation remain high and in case of cold weather
IPO remain undervalued. It can be said that there are wide variety of factors that have impact on
IPO valuation. These factors need to be taken in to consideration while making investment
related decision. It can be said that scope of present research study is wide and readers will
obtain a lot of information about research topic from current research work. In the present
research study in data analysis section specific IPO valuation model will be used which include
price earning ratio and price to book ratio. There is great improtance of both sort of ratios for
investors and other decision makers. Price earning ratio is the one of the most important ratio
because it reflect whether shares are undervalued or overvalued in nature. Formula of price
earning ratio will be used for valuation and under this simply price earning ratio of company will
be computed that launched its IPO in the market and same will be compared with the other peer
firms and on that basis it will be identified whether firm shares are undervalued or overvalued. It
must be noted that price earning ratio is widely used for valuation of firms IPO. This is because
by comparing with industry peers it is eaily find out whether firm shares are available at cheaper
price or one is paying high amount of price for firm shares. Price earning ratio in current time
period is used almost by all sort of investors whether they are retail investors or large size
corporates. All these facts revealed that there is huge importance of price earniing ratio for
investors. In case of price earning ratio simply market price is divided by earning per share and
on the basis of comparison of computed value it is identified whether shares are accurately
valued or are underpriced in nature. Price to book ratio is another approach that will be taken in
to account for valuation purpose in present research study. Use of both tools will help in making
proper valuation of IPO.
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Research type
There are two sort of researches that are conducted by researchers namely primary and
secondary research. Primary research refers to the process under which fresh or new data is
collected from the market which can never be observed in any other website. On other hand,
secondary research refers to the data that is gathered from sources like books, journals and
magezines. These are those informations that are already gathered and published by someone.
Both primary and secondary research is done at large scale by the business firms (Dunne, 2011).
This is because sometimes according to research requirements it is better to gather secondary
data to arrive at specific point. On other hand, primary resarch is conducted by the business firms
when they want to identify trends that are currently in the market. There is significence of both
primary and secondary research and it depend on research topic and thinking of individual that
which approach they select to conduct research. In present research study both primary and
secondary research will be done. Secondary research will be done to prepare literature review
section of the report and to devlop good understanding about research topic. On other hand,
primary research will also be done so that reliable data can be gathered and current trends can be
identifid in respect to research subject.
Research approach
Research approach refers to the specific way in which entire research work will be
carried out. It is very important to follow appropriate approach in research study because it
ensured that research will be done in right direction. It is very important to ensure that research
approach is selected according to research topic. Usually, there are two sort of research
approaches namely inductive and deductive approach. Both research approaches are totally
different from each other (Cecez-Kecmanovic, 2011). In case of inductive approach new theory
is developed on the basis of research. Under this first of all aims and objectives of research study
are determined and on that basis past literatures are analyzed. It is identified that what were the
view points of authors on research topic. On the basis of literature review broad understanding of
research topic is developed. In fourth stage data is gathered from several sources and same is
analyzed and on that basis research theory is developed. In case of deductive approach inverse is
obsrved and it is identified that in case of deductive approach already theory is developed and by
formulating hypothesis same is teted. On this basis it is identified whether theory is true or not.
In current research study inductive approach will be taken in to account because on basis of
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analysis of data theory will be developed in research study as in current research study attempt is
not made to prove hypothesis. This indicate that apprpriate approach is taken in to account for
current research study
Research design
There are three sort of research design methods namely exploratory, descriptive and
experimental research design. Both these research designs are different from each other as in
case of exploratory research design one does not know anything about research topic and wants
to develop understanding about it from starting point. On opposite to this there is other research
design namely descriptive research design and it is used when one have knowledge of research
topic but same intends to extend its knowledge about same (Pickerd and et.al., 2011). Thus, it
can be said that exploratory and descriptive research design are different from each other. On
other hand, there is another research design experimental research design and it is used when one
wants to conduct scientific research. In present research study exploratory research design will
be taken in to account because in current research study in sufficient quantity secondary data is
gathered to develop good understanding of research topic. Thereafter primary data will be
analzyed. Thus, exploratory research design is used in current research study and by using same
research is carried out in right direction. Questionairre or interview of experts will be taken under
which different questions will be asked from them so as to collect relevant primary data in proper
manner. Under questionnaire some of questions will be included that will be related to literture
review different themes like IPO valuation methods, hot and cold weather and IPO performance
as well as other important concepts. It can be said that appropriate approach is selected in present
research study to explore research study in proper manner.
Research philosophy
Research philosophy is one of the most important section of present research study.
Research philosophy can be classified in to different categories namely interpretivism and
positivism philosophy. There is difference between both research designs and both are applied in
different research studies. Positivism research philosophy is used in research studies that are
scientific in nature. Contrary to this, interpretivism philosophy is used in those research study
which are non scientific in nature (Clarke and Fujimura, 2014). Current research study is not
scientific in nature and due to this reason interpritivism philosopy is used in present research
study. Both research philosophy have due importance for researchers and they according to their
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needs make use of these in research study. It depends on research requirements that which of
research design an individual select in respect to its research study. It is necessary to select
appropriate sort of ressearch design in study because if same will not be done then in that case
appropriate appraoch to collecct data can not be determined. Due to this reason selection of
appropriate research design, approach and philosophy is important in the research study.
Positivism philosophy is usually used in those research study where one prepare hypothesis in
order to identify whether specific theory really exist (Morgan, 2013). In order to check that
theory statistical tools are applied on data set in proper manner varied assumptions are tested
while applying models on data set. In this way, hypothesis testing is done and it is identified
whether theory really implement in the world.
Data collection
Data collection is considered as one of the important part of the research methodology
section of any report. Multiple sources are available as secondary sources and from same
secondary data can be gathered by the researchers. Apart from this, there are many ways by
following which primary data can be collected. Usually, primary data is collected by conducting
interview and by distributing questionnaires among respondents. In the present research study
primary data will be gatheredby conducting interview among respondents. This is because
research study topic is techical in nature and common man does not have very strong knowledge
of research topic. Hence, primary data will be gathered from knowldgeable people by conducting
interview. Questionnaires will be distributed among proffesional people that have strong
knowledge of market ( Mackenzie and et.al., 2012). By doing so it will be ensured that data is
collected from relevant sources. While conducting research it is very important to select
appropriate approach of data collection. This is because for every research one need to collect
specific sort of data. In interview few questions will be asked from interviewees which will be
very specific in nature and will help in achieving aims and objectives of research. There are
number of alternative sources that are available to the business firms in respect to data collection.
It depends on researcher that from which source it prefers to gathered data for research study.
While selecting any source for data collection one must identify advantages and disadvantages of
each source of information and accordingly must select specific one to conduct research.
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Data analysis
After data collection analysis of same is done in research studies. In order to analyze data
there are two major techniques that are available to researchers like thematic analysis and
application of statistical tools like SPSS. In current research simple interview of proffesionals
will be taken and after gathering details from them analysis of same will be done. In this way it
will be identified whether investmennt model prepared really is effective for IPO valuation.
Secondary data of IPO related firms will be taken and valuation of same will be done by using
price earning ratio and price to book ratio. Under this approach simple price earning ratio of firm
that launch IPO in market will be compared with peer firm IPO and in this way it will be
identified whether firm IPO was overvalued or undrvalued. Apart from price earning ratio price
to book ratio will also be taken in to consideration. Price to book ratio is also one of the most
important ratio as if value is less then one it is assumed that firm shares are overvalued or vice
versa. In this way entire data will be analyzed in present research study (Cecez-Kecmanovic,
2011). In many research study simply thematic analysis are done and under this charting of data
collected from different sort of people are done. On anaysis of charts it is identified that in which
direction respondents give response to asked questions. In case of SPSS analysis things are
totally different as it can be observed that in this inferential statististical techniques are used for
analysis of data and to identify relationship among variables. SPSS will not be used in the
present research study because simply in research questions set for interview will be
communicated to respondents and by analyzing their responses analysis will be done. Hence,
there is no need to apply thematic analysis on data in present research study. SPSS is usually
used in scientific research studies because in such kind of studies main aim is to explore
relationship between variables and to make prediction. Main aim of present research study is to
identify thinking that people have in respect to research topic. Hence, thematic analysis approach
also does not seems better approach to analyze data along with SPSS. It can be said that by
analyzing data by using thematic analysis method better results can not be obtained. In this
way, data will be analyzed in research study.
Ethics
In every proffesion there are some ethical standards that need to be followed. In research
also there is need to follow some ethics in order to ensure that research is carried out in
legitimate way and privacy remain maintained during entire research study. Usually, it is
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assumed that in every research study or any prooffession as much as possible ethics must be
followed (VanPatten. and Williams, 2014). This is because it ensured to front person that
relevant work will be done in proper manner and it is reliable in nature. In the present research
study secondary data will be taken from multiple sources like books, journals and websites. It
will be ensured that only from relevant books, journals and websites data is gathered. By doing
so ethical standards will be folowed and it will be enbsured to readers that they can rely on
obained results and can made decisions. As part of ethical practice it will be ensured that entire
data will be stored in excel which will be password protected as unknown person will not be able
to open excel sheet easily. Ethics are very important to follow in order to ensure respondents that
every thing will be secured and no one will be able to steal or view their data. It will also be
ascertain that sufficient number of respondents are taken in project. This will be done because
many times in research when small sample is taken accurate or reliable results are not obtained.
In order to ascertain that useful and accurate results are generated by research sufficient sample
size will be taken of sufficient size and it will made certain that all respondents have sufficient
knowledge of research study. This will ascertain that readers are reading reliable facts and
figures from the research report and can obtain good results if make decision by considering
conclusion and recommendation related to research topic.
Validity and reliability
Validity and reliability is the one of the most important feature of research studies. In this
section of research study it is ensured that research is carried out on right direction. Usually in
research one need to pay due attention to number of factors and many times some important
aspects of research are missed out and in such kind of situation there is high probability that
research may go in wrong direction. In order to avoid such kind situation validity and reliability
section is prepared in the report. In current research every attempt is made to ensure that there is
validity and reliability of present research study (Morgan, 2013). Validity ensure that sources
from which information taken for research study must be valid means that sources from which
data gathered must be authentic in nature. Reliability is another important featuer of research
study as it reflect that data that is collected for study must be fully reliable in nature. Means that
data must not only collected from valid source but it must also be ensured that collected data is
reliable and it will help researcher in generating accurate results from research. If accurate results
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are obtained then in that case better decisions can be taken by those who read report for specific
purpose.
Research limitation
There are few limitatons of the research work as big sample size is not taken in study.
Due to this reason it is possible that to some extent results of research may deviate from actual
facts. In order to fix this problem an attempt is made to ensure that only those candidaes are
taken in research study that have sound knowledge of research subject. Thus, it can be said that
there re few limitations of research study but steps are also taken on time to solve problem. In
every research study some of limitations are observed and in current research also same thing is
seen. It is observed that in past time period also many researches are conducted which product
very reliable results but such kind of research studies also have some limitations. In present
research every step is made to ensure that weakness of research study is eliminated completelty.
Thus, it can be said that every effort is made to make research study more reliable in nature. By
doing so to some extent research limitation is eliminated by researcher. Small sample size can
obviously considered as limitation of research but it also acts as one of core strength of same. It
is clear that sample size is small but it is also true that proffesional people will be consulted in
order to gathered data and to obtain relevant information in respect to research subject. Hence, it
can be said that research major limitation is also its major strength.
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CHAPTER 4: DATA ANALYSIS
Transcription
Interview was conducted for 5 fund managers. Moreover, 2 people were used to conduct
the pilot study which helped in assessing that whether the company is able to collect appropriate
amount of the data from stated questions or not. Further, changes will be made to the questions
that can asked to the actual fund managers.
Based on the pilot studied carried out, following transcription have been received:
Theme 1: Understanding related to IPO
Interviewee 1: I have basic understanding regarding IPO. It is when first sale of stock is issued
to the public. Before this process, the entity is considered as private in nature. The small number
of shareholders are extended for the first time. In this manner a private company can convert
itself into public. The shares are sold to public and can enjoy the rights of the public company as
well.
Interviewee 2: I have intermediate level of understanding with respect to Initial Public offering.
Like the name reflects, it is for the first time when some private company make the investment
public. Public is open to invest in the company. It shows that it is going public. The ownership is
then transferred to the stockholders rather than the management of the company.
Theme 2: Type of investment model chosen by you for decision making process
Interviewee 1: There are various factors that are considered by me before making any
investment in IPO. The financial statement of the company must reflects high performance
through high revenue and increasing profits over the year. The brand image of the company also
help in assessing the condition to a great extent. Further, I also make analysis of the future
prospects of the company and if I find that the company is fruitful for me, then only I make
investment in it. Analysis is the most important part if the investment is made right, the return
generated from it will also be good for the investor. Appropriate consideration must be made to
assess that whether the IPO will be reflecting better position of the stock. The position reflected
must be correct and not biased.
Interviewee 2: IPO model used by me must not be biased and must give adequate information
regarding the IPO. Further, it is also important that adequate factors are considered while
reaching to the conclusion. The IPO must reflect the position of the stock and profit and loss
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related to it. Appropriate position reflected by the IPO helps in providing adequate and reliable
information to the investors. It helps in giving information to the investor which is authentic and
reliable as well.
Theme 3: Appropriation of the model being selected for analysis of IPO
Interviewee 1: The model that have been selected for the purpose of IPO analysis is appropriate
enough to understand how the IPO of the company is doping. The model has taken into
consideration P/E ratio which is the ultimate reflector of assessing the share price of the
company. It also reflects how the company is performing and how the IPO or stock of the
company is going to perform in the near future. However, the main issue I have found in the
model is that it do not consider the fluctuation in the price of the share and just takes into
consideration the opening and closing price. However, the average price would have given better
results than the return used in the model.
Interviewee 2: I analysed the overall model and found that the selected model for IPO valuation
is not appropriate enough to make the assessment of it. In depth analysis could have been
performed by the analyst. Further, the parameters used to analyse the IPOs are much specific and
hence can not be applied to the high market cap and low market cap companies. Since, the IPO
have been registered in 2015 and 2016 only. It is difficult to asses the performance through
various parameters as well. The constraints applied to this model are extreme enough making it
difficult for assessing every type stock on it.
Theme 4:
Interviewee 1:
Interviewee 2:
Theme 5:
Interviewee 1:
Interviewee 2:
Based on the main interview conducted through the fund manager, following transcript
have been received:
Theme 1:
Interviewee 1:
Interviewee 2:
Theme 2:
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Interviewee 1:
Interviewee 2:
Theme 3:
Interviewee 1:
Interviewee 2:
Theme 4:
Interviewee 1:
Interviewee 2:
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REFERENCES
Books and Journals
Baron, D. P., 1982, "A model of the demand for investment banking advising and distribution
services for new Issues", Journal of Finance, 37, pp. 959-976
Beatty, R and J. Ritter, 1986, "Investment banking, reputation and the underpricing of initial
public offerings", Journal of Financial Econontics, 15, pp. 213-232
Beatty, R., S. Riffe, and R. Thompson, 2002, "IPO pricing with accounting
Bruton, G.D. and et.al., 2010. Governance, ownership structure, and performance of IPO firms:
The impact of different types of private equity investors and institutional environments.
Strategic management journal. 31(5). pp.491-509.
Cecez-Kecmanovic, D., 2011. Doing critical information systems research–arguments for a
critical research methodology. European Journal of Information Systems. 20(4). pp.440-
455.
Chan, Y.C., 2010. Retail trading and IPO returns in the aftermarket. Financial Management.
39(4). pp.1475-1495.
Clarke, A.E. and Fujimura, J.H. eds., 2014. The right tools for the job: At work in twentieth-
century life sciences. Princeton University Press.
Contemporary Accounting Research, 11, pp. 661-687.
Dong, M., Michel, J.S. and Pandes, J.A., 2011. Underwriter quality and long‐run IPO
performance. Financial Management. 40(1). pp.219-251.
DuCharme, L., P. Malatesta, S. Sefcik, 2001, "Earnings management: IPO valuation and
subsequent performance", Journal of Accounting, Auditing & Finance, 16, pp. 369-397.
Economics, 15, pp. 187-212
efficiency", Journal of Financial Economics, 55, pp. 361-389.
Feltham, G. A, J. S. Hughes, and D. A. Simunic, 1991, "Empirical assessment of the impact of
auditor quality on the valuation of new issues", Journal of Accounting and Economics, 14,
pp. 375-399.
Financial Statement Analysis, 2, pp. 23-39
How, J. Y. C and J. J. L. Yeo, 2001, " The impact of forecast disclosure and accuracy on equity
pricing the IPO perspective", Journal of Accounting, Auditing and Finance, 16, pp. 401-
425.
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Hutagaol, Yanthi (2005) IPO valuation and performance: evidence from
Ibbotson, R and J. Jaffe, 1975, "Hot issue markets". Journal of Finance, 30, pp. 1027-1042
information", Southern Methodist University working paper series.
Johnson, J. and R. Miller, 1988, "Investment banker prestige and the underpricing of initial
public offerings", Financial Management, 17, pp. 19-29.
Klein, A., 1996, "Can investors use the prospectus to price IPOs? ", Journal of
Lee, J.S., Kuo, C.T. and Yen, P.H., 2011. Market states and initial returns: Evidence from
Taiwanese IPOs. Emerging Markets Finance and Trade. 47(2). pp.6-20.
Logue, D. E, 1973, "On the pricing of unseasoned equity offerings: 1965-1969", Journal of
Financial and Quantitative Analysis, 8, pp. 91-103.
Loughran, T. and J. Ritter, 2000, "Uniformly least powerful tests of market
McCarthy, E., 1999, "Pricing IPOs: science or science fiction", Journal of Accountanpcp.y 5,1 -
58
Morgan, G., 2013. Riding the waves of change. Imaginization Inc.
Ohlson, J., 1995, "Earnings, book values and dividends in equity valuation",
Pickerd, J. and et.al., 2011. Individual accounting faculty research rankings by topical area and
methodology. Issues in Accounting Education. 26(3). pp.471-505.
Rock, Kevin, 1986, "Why New Issues are Underpriced", Journal of Financial
the UK main market. PhD thesis.
Dunne, C., 2011. The place of the literature review in grounded theory research. International
Journal of Social Research Methodology. 14(2). pp.111-124.
Mackenzie, J. and et.al., 2012. The value and limitations of Participatory Action Research
methodology. Journal of hydrology. 474. pp.11-21.
Cecez-Kecmanovic, D., 2011. Doing critical information systems research–arguments for a
critical research methodology. European Journal of Information Systems. 20(4). pp.440-
455.
VanPatten, B. and Williams, J. eds., 2014. Theories in second language acquisition: An
introduction. Routledge.
Morgan, G., 2013. Riding the waves of change. Imaginization Inc.
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APPENDIX
Questions for Pilot study
Question 1: Do you understand the meaning of IPO?
Ans ________________________________________________________________
Question 2: What type of IPO model will be chosen by you for decision making purpose?
Ans ________________________________________________________________
Question 3: Do think the model used is appropriate enough? If not, what must be the inclusion?
Ans ________________________________________________________________
Question 4: Is the model applicable in real world?
Ans ________________________________________________________________
Question 5: What input do you want to give to the present questionnaire?
Ans ________________________________________________________________
Questions to Fund Manager
Question 1: Will the IPO model be considered by you with the view of investment?
Ans _______________________________________________________________
Question 2: What is the reason of choosing this IPO model?
Ans ________________________________________________________________
Question 3: What are the factors that you think that must be present in the model? Moreover,
any other comment?
Ans ________________________________________________________________
Question 4: Is there any difficulty that you face in applying this model in real world?
Ans ________________________________________________________________
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