An Empirical Analysis of the Implicit Growth Rate for Industrial IPOs Listed in Pakistan

Abstract

This study examines the cash flow growth rate implicit by offer prices of industrial IPOs using a reverse engineering DCF model. In addition, this study also investigates the bias of implicit growth relative to the realised growth rate by considering 19 IPOs listed on Karachi Stock Exchange during the period from 1995 to 2008. We find that the estimated growth in cash flows is slightly higher than realised growth rate, which indicates that the median IPO firm is overvalued by 61.5 percent at the offering. It is observed that estimation errors increase as a result of higher underpricing and diversified ownership. In addition, post-IPO returns are smaller for issues whose implicit growth rates are biased upward. We also find that IPOs underperform in long-run employing a buy-and-hold investment strategy. The policy implication of the study is to evolve a price discovery mechanism by the Securities and Exchange Commission of Pakistan which may help to reduce the overvaluation of IPOs upto some extent. JEL Classification: G00, G30 Keywords: Initial Public Offerings, Reverse Engineering DCF Model, Valuation, Growth Rate