Valuation of unseasoned stocks and the underpricing phenomenon

• Main Authors: Goh, Stephanie Giok Lie, Leong, Wai Mun, Sin, Kok Hong
• Other Authors: Lance Eric Brannman
• Format: Final Year Project
• Language: English
• Published: 2015
• Subjects: DRNTU::Business
• Online Access: http://hdl.handle.net/10356/64351
• Institution: Nanyang Technological University

In recent months. Initial Public Offers (IPOs) in Singapore have proven to be an almost guaranteed source of capital profit because most new issues have been oversubscribed and investors in these unseasoned stocks have reaped substantial gains. This project seeks to examine two aspects of IPOs. First. the underpricing phenomenon of IPOs will be observed through a stock-valuation model on an exante basis as opposed to an ex-post basis. This is achieved by comparing the forecast price of the new stock (obtained through the model) against the issue price . Second, the accuracy of this model in predicting the price of the stock on actual listing will be examined. The chapter on literature review examines three broad areas of literature relating to this project. The first section deals with institutional arrangements and the stock exchange listing requirements. The second section examines the many theories underlying the underpricing phenomenon of IPOs. The third looks at the types of models which are being used by stock analysts to value common stocks. The stock-valuation model used in this project was determined as follows: Cross-sectional regression analysis was used to determine the weights the market places on a set of hypothesized determinants of common stock prices. Once the weights for the determinants were obtained, the relevant financial characteristics of the firms seeking initial listing (i.e ., the IPOs) were then plugged into this equation to obtain a forecast price for the unseasoned issue. These forecast prices, which represent the markets valuation of stock. were then compared with the issue prices and actual listing prices to establish underpricing and the accuracy of the stock v aluation model respectively . The analysis of results re v ealed two interesting - - observations . First, all the forecast prices (P1) obtained from the model were higher than the issue prices (P;) given in the prospectus. This clearly indicates the existence of underpricing of these IPOs. Second, most of the forecast prices (P1 ) were also higher than the actual closing prices (PJ on the first day of listing. This can be rationalized as follows : Since the model uses characteristics from seasoned stocks to price the IPOs. this could explain why the forecast price based on the model is generally higher than the actual listing price of the IPOs (which are riskier than seasoned stocks) . Alternatively , we know that the financial characteristics of companies seeking listing were taken from the IPO prospectus. The figures within are based on projected figures given by management. Potential investors and stock analysts who represent the market might discount these forecasted figures, whereas the stock valuation model used in this project does not. This may thus result in lower actual prices on the first day of listing as compared to the forecast price predicted by the stock valuation model.