Clearly, the euphoria around IPOs is palpable. (The Paytm debacle notwithstanding.)
One aspect of this IPO punting business that really gets people going has to do with what’s happening “outside” the legit markets.
We are talking about the grey market. The market that operates outside the boundaries set for formal markets.
It is here, at least in some portion, that the IPO punters get their kicks. And they get it by tracking what’s called the grey market premium (GMP).
Today, let’s dig deep into the IPO grey market and understand what this is all about.
Knowledge of the grey market is a prerequisite for understanding the concept of GMP. So, let’s start by understanding what the grey market is.
The grey market is an unofficial market that exists in parallel with the official market. In the context of IPOs, the grey market is where unlisted IPO shares are traded.
And the grey market premium or GMP is the amount, over and above the issue price, that traders are willing to pay or ask for to trade these yet to be listed IPO shares.
An example would certainly help to clear any confusion you may have.
Suppose a company announces its IPO. The company offers a single share at ₹100. The price at which the company offers its shares is called issue price.
Soon after the allotment of shares is finalized, the shares of the company start trading in the Grey Market. Let’s assume the GMP of the company in consideration is quoted at ₹50 per share.
If you decide to buy the shares in the grey market, how much will you have to pay to grab these in demand shares?
You will have to pay, Issue price + GMP = 100 + 50 ⇒ ₹150 per share.
In the example discussed above, if the GMP of the company is quoted at (-) ₹10 per share then you would have to pay ₹90 per share to obtain the shares of the company.
Now that you have understood what GMP is, let’s move on…
What is the significance of GMP? Why is it so popular amongst small investors?
You see, it is assumed that the grey market “knows” what’s about to happen on listing day.
And that’s why the GMP effectively reflects the estimated premium (or discount) at which the shares of the company may list on the stock market.
So, if you thought you needed to wait for listing day to figure out what’s about to happen…well, you are not a true-blue IPO punter, yet.
IPO punters know what’s about to happen. Whether that transpires or not is altogether another matter.
Let me show how this works in reality with the help of a few examples of recently listed companies…
Example 1: Sigachi Industries
Shares of Sigachi Industries got listed on the exchanges on 15 November 2021.
The shares were being traded in the grey market at a premium of 138% to its issue price.
On the day of listing, the shares were listed at a premium of 252% to its issue price. The premium at which the shares were listed was 2X of GMP.
This implies that the IPO punter who bought shares in the grey market at a big GMP, still made money on listing.
On the flip side, the person who sold, sold too cheaply.
Example 2: Paytm
The GMP of Paytm indicated that the shares may list at a discount of 0.7% to its issue price.
Yes, that’s right. A discount of 0.7% was all the grey market expected.
But we all know what happened on listing day. It was a debacle.
The person who sold his shares at this almost zero GMP was quite smart as well as lucky to find a buyer for his shares …and what about the buyer? Well, all we can say is that this time the odds were not in his favour.
Now, let’s have a look at the GMP of upcoming IPOs…
Following table shows the listing price of past IPOs indicated by GMP versus actual listing price
Should you trust the GMP?
The GMP gives you an idea of the market’s perception of an IPO and how it will perform on the listing day.
If you are looking forward to applying for an IPO, sure take a look to see what could happen on listing day.
But remember it shouldn’t be the only factor influencing your decision on whether or not to hold or exit the stock.
If you are an investor, then we would say take the GMP with a pinch of salt.
There have been many instances of investors losing their money as the shares didn’t list at a price indicated by the GMP. Paytm for instance.
A factor as volatile as GMP can’t be a deciding factor.
Therefore, you should never apply for an IPO just because it commands a good GMP. You should apply for an IPO because you believe in the company’s earning potential. Hence more weightage should be given to the fundamentals of the company.
This article is syndicated from Equitymaster.com
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