Have you ever wondered why some Initial Public Offerings (or IPOs) perform well while others don't? The way an IPO is priced can significantly impact its success and your potential returns. Take the example of Paytm's IPO, which was highly anticipated but saw poor listing gains, leading to concerns about its valuation. Listing gains are the profits you earn if a stock's price at listing exceeds its IPO price.
To help you navigate the stock markets effectively, let’s explore the different types of IPO pricing and gain essential insights about how it works.
An IPO is when a company sells its shares to the public for the first time. A share represents a small ownership in the company. IPO helps the company raise money to grow and expand. It also means that these shares can be bought and sold by anyone on the stock market.
In a fixed-price IPO, the company's underwriters determine a specific price at which the shares will be offered to the public.
To understand this better, let's suppose that a company named Tech Innovators Ltd wants to go public. It offers its shares at a fixed price of ₹500 each. Here’s how it works:
- Setting the Price: Tech Innovators Ltd. and its underwriters evaluate its financials and market conditions and decide that ₹500 per share is the fair price for its IPO.
- Public Announcement: This price is then included in the prospectus, which is shared with potential investors.
- Investor Decisions: Prospective investors can review the prospectus and decide whether or not to buy shares at this price.
- Subscription: If they believe ₹500 is a reasonable price, they can subscribe to the IPO. The company will raise capital based on the number of shares sold.
This method provides clarity and helps investors know exactly what they need to pay. However, if the price is set too high, there might be fewer subscriptions, and if set too low, the company may not raise as much capital as it could have.
Also read: Tips to Invest in IPO
In a book-built IPO, the price of the shares is not fixed. Instead, the company provides a price range and allows investors to place bids within that range. The final price is determined based on these bids.
Consider that a company named Eco Green Solutions Ltd. is planning an IPO. Instead of a fixed price, they set a price band of ₹400 to ₹450 per share.
- Price Band: Eco Green Solutions Ltd. and its underwriters decide on a price range of ₹400 to ₹450.
- Bidding Process: Investors place bids within this range, stating how many shares they want to buy and at what price.
- Book Building: During the bidding period, the company collects all the bids.
- Price Discovery: After the bidding period closes, the company reviews the bids to determine the demand. If most bids are around ₹430, they might set the final price at ₹430.
- Allocation: Shares are then allocated to the investors who placed bids at or above ₹430.
This process helps the company discover the best price based on actual market demand, often leading to more efficient pricing and better subscription rates.
Several key factors differentiate IPO offerings, and understanding these can help you choose the right investment. Here are some critical elements:
|
Key Elements |
Fixed-Price IPO |
Book-Built IPO |
|
Pricing Method |
Provide a predetermined share price set before the IPO, offering investors clarity and simplicity in pricing decisions. |
Offer a price range for investors to bid on, with market demand determining the final price. |
|
Investor Categories |
Typically target a broad spectrum of investor categories, ensuring equal access to shares among all types of investors. |
May have separate allocations for institutional and retail investors. |
|
Subscription Period |
Usually have a shorter subscription period, giving investors a limited window to participate in the offering. |
Typically feature a longer subscription period to accommodate the book-building process. |
|
Allotment and Listing Process |
Shares are allotted at a predetermined price, and the listing process follows shortly after the IPO closure, offering investors immediate liquidity. |
Shares are allocated based on bids received during the book-building process, which impacts the final price and allotment. |
In a book-built IPO, the company sets a price range for shares, and investors place bids within this range. The final price is determined based on demand, with shares allocated to those who bid at or above this price.
Be aware that companies and underwriters often aim for higher prices to maximise capital, potentially leading to overvaluation. Market conditions also play a significant role—strong markets can boost prices, while weak markets can suppress them.
Thoroughly research the company’s financials, market conditions, and underwriter reputation. Understand the risks and be prepared for volatility post-IPO. Making an informed decision requires careful evaluation, not just following the hype.
Investing in IPOs offers a unique opportunity to be part of a company’s growth story from the beginning. You can make more informed and strategic investment decisions by understanding the different types of public offerings and the key elements that differentiate them. Whether you prefer the transparency of fixed-price issues or the market-driven approach of book-built issues, being well-informed is the key to being a successful investor.
Learn more about IPOs and enhance your investment knowledge with resources from the Sharekhan Knowledge Centre. Understanding the different types of IPOs can better equip you to navigate the exciting yet complex world of initial public offerings.
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