Pricing IPOs, Using Two-Stage DEA to Track their Financial Fundamentals

In order to assess the long run price potential of an IPO, we compute a piece-wise linear price frontier of similar stocks already present in the stock market. Drawing on so-called Fundamental Analysis of stocks (Ou, Penman, Abarbarell and Bushee, and others), stock prices are linked to underlying financial data in two consecutive steps: a predictive information link tying current financial data to nature earnings, and a valuation link tying future earnings to firm value. A new procedure of two-stage data envelopment analysis is employed to fit a piecewise linear efficiency frontier to the observed data for each of these two steps. The procedure is illustrated by a numerical example, analyzing five IPOs in the Spanish manufacturing industry (and comparing them with industry performance) occurring in the years 1991–96.