Pakistan Institute of Development Economics



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

This study examines the cash flow growth rate implicit byoffer prices of industrial IPOs using a reverse engineering DCF model.In addition, this study also investigates the bias of implicit growthrelative to the realised growth rate by considering 19 IPOs listed onKarachi Stock Exchange during the period from 1995 to 2008. We find thatthe estimated growth in cash flows is slightly higher than realisedgrowth rate, which indicates that the median IPO firm is overvalued by61.5 percent at the offering. It is observed that estimation errorsincrease as a result of higher underpricing and diversified ownership.In addition, post-IPO returns are smaller for issues whose implicitgrowth rates are biased upward. We also find that IPOs underperform inlong-run employing a buy-and-hold investment strategy. The policyimplication of the study is to evolve a price discovery mechanism by theSecurities and Exchange Commission of Pakistan which may help to reducethe overvaluation of IPOs upto some extent. JEL Classification: G00, G30Keywords: Initial Public Offerings, Reverse Engineering DCF Model,Valuation, Growth Rate

Muhammad Zubair Mumtaz,

Zachary Alexander Smith,

Ather Maqsood Ahmed