Understanding how IPO listing price is decided: This blog is going to talk about one of the most exciting concepts in the stock market – IPOs or Initial Public Offerings.
An IPO is basically a company issuing its shares on one or more stock exchanges. This is done to raise capital, among other reasons. Yet the process is more complex.
For instance, the promoters of the company need to decide the number of shares and chose an investment bank to take them public, maintain audited accounting records, etc.
In this blog, we’ll answer an important question regarding IPOs –
How IPO listing price is decided?
The listing price is the opening price of a share when it first lists on the stock exchanges. This happens after the IPO, which usually lasts for three days.
During those three days, retail investors have the chance to subscribe to the shares. Before going ahead, you must understand that the listing price is not the same as the offer price.
They are two different prices altogether. For this let’s understand the 2 markets that exist i.e. the primary and the secondary market.
The primary market is the market for new issues. This is where companies raise funds from the public in exchange for shares. The secondary market is where investors buy shares from other investors.
The offer price of an IPO is already set by the investment bank involved with the IPO and is used in the primary market.
The listing price is decided by the demand and supply of the shares in the secondary market. The halfway point between them is the listing price.
This figure is decided based on all the orders received for the shares when it debuts on the exchanges. This is called price discovery.
Meaning of IPO Valuation To Investors
If you decide to bid for an upcoming IPO, here is why you should know the valuation process –
- This affects the IPO issue price. This is the price at which you buy the shares. If you are participating in the IPO, then it is always beneficial to know if you are paying more or less than what the asset i.e. the shares is worth.
- To investors, the valuation gives a clearer picture of a company’s business prospects in the future. This is important because if your investment has to grow, so should the company. For that, it needs to have potential growth opportunities.
- An objective evaluation allows you to look past the hype, advertising, and unsolicited advice from different agencies. Also, researching the financials of a company gives you a clear and transparent picture.
Components Of IPO Valuation
Here are some of the key components that make their way into determining the valuation of an IPO.
1. Demand
Considering the demand, the understanding is straightforward – It refers to how important and big investors consider an IPO. A perfect example is the listing of LIC (India) – the biggest IPO in India so far.
The IPO was subscribed 2.95 times and their IPO price was ₹949. The government was looking to raise ₹21,000 crores just through its OFS (Offer For Sale).
While the IPO had huge demand, the insurer was listed at a discounted price of ₹865. When the demand for the shares exceeds supply, then the listing price will be higher than its offer price.
This is also called listing at a premium. When the demand is lower than the supply of shares, then the stock is listed at a discount. On rare occasions, when supply and demand match, the stock lists at par with its offer price.
Though demand is important, it doesn’t necessarily mean that the company will do well in the market. And lastly, if the demand in the market is low due to overvaluation then the shares may list at a lower price than the issue price which is also known as listing at a discount.
2. Growth Potential
Every company that goes public needs to state what it will do with the funds. This could be reducing debt, business expansion, new products or service lines, etc.
In short, the capital has to be used to grow the business. But, if its only reason to go public is to reduce debt, then this could keep potential investors away.
Most investors prefer companies that have future goals and ambitions that scale the company and investor wealth with it.
Take, for example, a company with a good track record of growth and profits. This type of company going public brings in huge attention from the investing community.
3. Competitors
If a company is going public, and its business has many listed competitors, then investors will compare its financials directly to the industry leaders.
If the performance doesn’t match the IPO, investors might find it overvalued and look elsewhere. Plus, listed companies with historical data look like a safer option compared to a company listing for the first time.
4. Grey Market Premium
This gives us an idea about what the listing price may be and understand what investors actually feel about the company. The grey market is where unlisted securities are traded.
This is a highly unregulated market, and it gives investors a hint of how the listing price of an IPO. A grey market premium is the extra amount investors will pay to buy the IPO shares.
Take an example
The offer price is ₹100 and the grey market price is ₹30. This means that an investor is willing to pay ₹130 for the share on the grey market. The premium is due to increasing demand for the IPO.
Many within the investing community look at the grey market before investing in an IPO. While it does give an idea about the listing price, it is not always correct.
5. Industry
The overview of an industry tells investors what they’re getting into. Even if everything about the IPO is good, there will be a chance it doesn’t perform because of the industry. Such factors are external and cannot be controlled.
Yet, they play a vital role when companies go public. An example to understand this better is the pharmaceutical industry and Covid-19. At the height of the pandemic, pharma companies were in focus on their importance and contribution.
Also Read: What Is The Cut Off Price In IPO? Meaning, Types & More!
In Closing
That’s all for this blog on – How IPO Listing Price Is Decided, We hope it answers your questions and leaves you with more knowledge and interest in investing.
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