The euphoria surrounding IPOs is obviously palpable. (Despite the Paytm debacle.)
One aspect of this IPO skahn business that really gets people going has to do with what’s going on “outside” the legal markets.
We are talking about the gray market. The market that operates outside the boundaries set for formal markets.
This is where the stock marketers get their money’s worth, at least in part. And they get it by following what is known as the gray market premium (GMP).
Today let’s dive deep into the gray IPO market and understand what it’s all about.
Knowledge of the gray market is a prerequisite for understanding the concept of GMP. So let’s start by understanding what the gray market is.
The gray market is an unofficial market that exists parallel to the official market. In the context of IPOs, the gray market is trading in unlisted IPO shares.
And the gray market premium, or GMP, is the amount that traders are willing to pay or be willing to charge above the issue price in order to trade these unlisted IPO shares.
An example would certainly help clear up any confusion.
Suppose a company announces its IPO. The company offers a single share too ₹100. The price at which the company offers its shares is called the issue price.
Shortly after the allotment of shares is complete, the company’s shares begin trading in the gray market. Let us assume that the GMP of the company in question is given below ₹50 per share.
If you decide to buy the stocks in the gray market, how much do you have to pay to buy those much sought-after stocks?
You have to pay, issue price + GMP = 100 + 50 ⇒ ₹150 per share.
In the example discussed above, if the company’s GMP is below (-) ₹You would then have to pay 10 per share ₹90 per share to get the company’s shares.
Now that you understand what GMP is, let’s move on …
What is the meaning of GMP? Why is it so popular with retail investors?
As you can see, it is assumed that the gray market “knows” what will happen on listing day.
Because of this, the GMP effectively reflects the estimated premium (or discount) at which the company’s shares can be listed on the stock exchange.
So, if you thought you’d have to wait for listing day to find out what’s about to happen … well, you’re not a real public trader just yet.
Stock marketers know what’s going to happen. Whether that prevails or not is a completely different matter.
Let me show you how this works in real life using a few examples from recently listed companies …
Example 1: Sigachi Industries
Sigachi Industries shares were listed on November 15, 2021.
The shares were traded on the gray market with a premium of 138% on the issue price.
On the day of the listing, the share was quoted at a premium of 252% on the issue price. The premium at which the shares were quoted was double GMP.
This implies that the stockbroker who bought stocks in the gray market at a major GMP was still making money from the listing.
On the other hand, the person who was selling was selling too cheaply.
Example 2: Paytm
Paytm’s GMP stated that the shares can be quoted at a discount of 0.7% on their issue price.
Yes that’s right. A discount of 0.7% was only expected from the gray market.
But we all know what happened on the trading day. It was a debacle.
The person who sold their stocks at this near-zero GMP was pretty smart and was lucky enough to find a buyer for their stocks … and what about the buyer? Well, we can only say that the odds were not in his favor this time around.
Now let’s take a look at the GMP of the upcoming IPOs …
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The following table shows the stock exchange price given by GMP for past IPOs compared to the actual stock exchange price
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Should You Trust the GMP?
The GMP gives you an idea of how the market perceives an IPO and how it will develop on the trading day.
If you are looking forward to applying for an IPO, be sure to take a look at what could happen on listing day.
But remember, this shouldn’t be the only factor influencing your decision whether to hold or not to sell the stock.
If you are an investor, we would say take the GMP with a pinch of salt.
There have been many instances where investors have lost their money because the shares were not quoted at a price quoted by the GMP. Paytm, for example.
A factor as volatile as GMP cannot be a determining factor.
Hence, you should never go public just because it offers a good GMP. You should go public because you believe in the company’s profitability. Therefore, more weight should be given to the fundamentals of the company.
Have fun investing!
This article was syndicated from Equitymaster.com
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