IPO Valuation and Pricing
Knowing that a company has good products and growing revenue is not enough to make an IPO investment decision. You also need to know whether you are paying a fair price for those attributes — or overpaying.
This is where valuation comes in. Valuation is the process of determining what a business is worth, and comparing that to what you are being asked to pay. It is arguably the most important skill in investing, and IPOs are no exception.
Why Valuation Matters in IPOs
Unlike buying shares on the secondary market — where price is set by supply and demand among thousands of investors — IPO pricing is set by the company and its investment bankers. Their incentive is to maximise the price they get for the shares being sold.
This creates an inherent tension. The company wants the highest possible price. You want to pay the lowest fair price. The DRHP's "Basis of Issue Price" section is the company's attempt to justify their ask.
Your job is to verify that justification independently.
The Core Valuation Metrics
Price-to-Earnings (P/E) Ratio
The most widely used metric. It compares the company's market capitalisation (share price × total shares) to its annual net profit.
Formula: P/E = Market Cap ÷ Net Profit (PAT)
Or equivalently: P/E = Issue Price ÷ Earnings Per Share (EPS)
What it tells you: How many rupees you are paying for every rupee of annual profit.
How to use it:
- Calculate the company's P/E at the IPO price
- Compare to the average P/E of listed peers in the same sector
- If the IPO P/E is significantly higher than peers, you need a compelling reason — higher growth, better margins, stronger moat
Limitation: Useless for loss-making companies. Also easily distorted by one-time items in profit — always use operating profit (EBIT or EBITDA) as a cross-check.
EV/EBITDA
Enterprise Value to Earnings Before Interest, Tax, Depreciation and Amortisation.
Formula: EV/EBITDA = (Market Cap + Debt - Cash) ÷ EBITDA
EV/EBITDA is more capital-structure-neutral than P/E — it accounts for debt and is unaffected by depreciation policies or tax rates. It is more appropriate for capital-intensive businesses (manufacturing, infrastructure, telecom) and for comparing companies across different tax jurisdictions.
How to use it: Same as P/E — compare to listed peers. A company trading at 20x EV/EBITDA in a sector where peers trade at 12x needs to justify that premium with demonstrably higher growth or returns.
Price-to-Sales (P/S) Ratio
Formula: P/S = Market Cap ÷ Annual Revenue
Used primarily for high-growth, loss-making companies where P/E is not applicable — common in new-age technology, SaaS, and platform businesses.
Caution: P/S can be dangerously misleading. A company with ₹1,000 crore revenue and ₹500 crore losses is not automatically worth 3x revenue just because a profitable peer trades at 3x. The path to profitability and capital efficiency matter enormously.
The 2021 technology IPO bubble was partly fuelled by uncritical P/S comparisons — investors paid US tech-like multiples for Indian companies with fundamentally different unit economics.
Price-to-Book (P/BV)
Formula: P/BV = Market Cap ÷ Net Worth (Book Value)
Most relevant for financial services companies — banks, NBFCs, insurance companies — where the balance sheet (loans, investments, deposits) is the core business.
A bank trading at 3x book is priced at three times its net assets. Whether that is justified depends on the quality of those assets (loan book quality), return on equity, and growth prospects.
The Peer Comparison Method
The most common valuation approach in DRHP documents. The company selects a set of listed peers and shows how their valuation metrics compare.
How to evaluate peer comparisons:
Step 1: Are the peers actually comparable? A company entering a niche segment should not be compared to a diversified conglomerate. Check whether the peers have similar business models, scale, and growth profiles.
Step 2: Are the peers fairly selected? Companies understandably cherry-pick peers with high valuations to make their own pricing look reasonable. Look for obvious omissions — cheaper peers that have been left out.
Step 3: Does the premium make sense? If the IPO is priced at a premium to peers, is there a clear reason? Higher growth rate? Better margins? Stronger market position? Or is it just optimism?
Understanding Market Capitalisation at Issue Price
Before applying, always calculate the company's full valuation at the IPO price:
Market Cap = Issue Price × Total Shares Post-IPO
This number tells you what the entire business is being valued at. Then ask: does this seem reasonable for a company of this size, in this sector, with this growth profile?
Example:
- Issue price: ₹500
- Total shares post-IPO: 10 crore
- Market cap at issue price: ₹5,000 crore
Is ₹5,000 crore a reasonable price for this business? Compare to revenue (P/S), profit (P/E), and peers. The answer to that question is your valuation verdict.
Valuing Loss-Making Companies
Many high-growth companies — particularly in technology, fintech, and consumer internet — come to the IPO market before they are profitable. Traditional P/E valuation does not work.
Alternative approaches:
Discounted Cash Flow (DCF): Project future cash flows and discount them to present value. Highly sensitive to assumptions about growth rates and discount rates — small changes in inputs produce wildly different valuations.
Path to profitability analysis: When does the company expect to become profitable? What is the burn rate? How much cash does it have, and will it need another fundraise before becoming self-sustaining?
Unit economics: Is each unit of the business (each customer, each order, each store) profitable on a contribution margin basis? A company can be overall loss-making but have healthy unit economics — meaning scale will eventually produce profit.
The Honest Truth About IPO Valuations
Investment banks earn fees based on the size of the IPO they take public. Their incentive is to maximise valuation. This does not make them dishonest — but it does mean their valuation analysis in the DRHP is not a neutral, third-party assessment.
Indian IPOs, historically, have tended to be priced at full or near-full valuations. The "listing gain" story — where you apply at the IPO price and sell on Day 1 for a profit — works because the market sometimes re-rates the company higher after listing, or because strong GMP and subscription drive listing day demand. It does not work because IPOs are systematically underpriced.
Approach every IPO valuation as a negotiation. The company is asking you to pay a certain price. Your job is to decide if that price is fair — and to walk away if it is not.