Equity Valuation for IPO: Hot and Cold Market Anomaly

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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