IPO Pricing: Growth Rates Implied in Offer Prices

Abstract

This paper studies the valuation of companies going public and defines a methodology to infer the growth expectations implicit in their IPO prices. The proposed reverse-engineered DCF model is operable by individual investors, as it does not require access to private information or sell-side analysts’ forecasts.

Applying the procedure to a sample of IPOs in three European countries (France, Italy, and Germany), we estimate the cash flow growth implied by offer prices and examine the bias of implied growth in comparison to the realized. We find that the estimated growth in cash flow is much higher than its actual realization, with the median IPO firm overvalued at the offering by 74%. Estimation errors increase with IPO firms’ leverage and underpricing, while decrease with age, size, and book-to-market ratios. Further tests find that post-IPO returns are lower for issues whose implied growth is more upward biased.

Keywords: Initial Public Offerings (IPOs), valuation, growth rates

JEL Classification: G30