Gray Market Premium – The Secret To IPO Investing Success?

Clearly, the enthusiasm for the IPO is clearly visible. (Despite the Paytm debacle.)

One aspect of this IPO punting business that really attracts people is getting “outside” of legitimate markets.

We are talking about gray market. Markets that operate outside the limits set for formal markets.

This is where, at least in part, IPO punters get their kick. And they achieve this by tracking the gray market premium (GMP).

Today, let’s delve deeper into the IPO gray market and understand what it is.

Knowledge of gray market is a prerequisite for understanding the concept of GMP. So, let’s understand what is gray market.

The gray market is an informal market that exists parallel to the official market. In the context of IPOs, the gray market is where Unlisted IPO Shares business is conducted.

And the gray market premium or GMP is the amount, which is higher than the issue price, that traders are willing to pay or are asked to trade in yet-to-be listed IPO shares.

An example would certainly help clear up any confusion you may have.

Suppose a company announces its IPO. The company makes a share offer 100. The price at which the company offers its shares is called the issue price.

Soon after the allotment of shares is finalized, the company’s shares start trading in the gray market. Let us assume that the GMP of the company is quoted taking into account 50 per share.

If you decide to buy shares in the gray market, how much will you have to pay to grab them in demand shares?

You have to pay, Issue Price + GMP = 100 + 50 150 per share.

In the example discussed above, if the company’s GMP is quoted in (-) 10 per share then you have to pay 90 per share to get the shares of the company.

Now that you understand what GMP is, let’s move on to…

What is the importance of GMP? Why is it so popular among small investors?

You see, it is assumed that the gray market “knows” what is going to happen on listing day.

And this is why GMP effectively reflects the estimated premium (or discount) at which a company’s shares may be listed on the stock exchange.

So, if you think you need to wait for listing day to know what’s about to happen… well, you’re not a true-blue IPO punter yet.

IPO punters know what’s about to happen. Whether this happens or not is another matter entirely.

With the help of a few examples from recently listed companies I show how it really works…

Example 1: Sigachi Industries

The shares of Sigachi Industries were listed on the exchanges on 15 November 2021.

The shares were being traded at a 138% premium to its issue price in the gray market.

The shares were listed at a premium of 252% over its issue price on the day of listing. The premium at which the shares were listed was 2X of GMP.

This means that the IPO punter who bought shares in the gray market at the big GMP still made money on the listing.

On the other hand, the one who sold it sold very cheaply.

Example 2: Paytm

Paytm’s GMP indicated that the shares may be listed at a discount of 0.7% on their issue price.

Yes that’s right. A discount of 0.7% was expected in all gray market.

But we all know what happened on the day of listing. It was a defeat.

The person who sold his shares at this near-zero GMP was smart enough to find a buyer for his shares… and what about the buyer? Well, all we can say is that this time things were not in his favor.

Let’s have a look at the GMP of the upcoming IPO…

The following table shows the listing price of previous IPOs as represented by GMP vs. Actual Listing Price

Should you trust GMP?

The GMP gives you an idea of ​​the market sentiment regarding the IPO and how it will perform on the day of listing.

If you are looking forward apply for ipo, of course, see what could happen on listing day.

But remember that it shouldn’t be the only factor influencing your decision about whether to hold or exit the stock.

If you are an investor, we would say take GMP with a pinch of salt.

There have been many instances of investors losing money due to the stock not being listed at the price indicated by the GMP. For example Paytm.

A volatile factor may not be the deciding factor as much as GMP.

Hence, you should never apply for an IPO just because it commands a good GMP. You should apply for IPO because you believe in the earning potential of the company. Therefore, more weightage should be given to the fundamentals of the company.

Happy investment!

This article is syndicated from Equitymaster.com