Every other week, you may come across a new Initial Public Offering (IPO) in the market. This is when a company lists its shares for trading for the first time. The stocks are then available in the secondary market—the regular market where much of the daily buying and selling happens.
So here are some practical tips to keep in mind while investing in IPOs:
Before you understand how to invest successfully, you need to learn how the process works. Unlike buying in the secondary market, you have to bid for shares. Every IPO offers shares in lots – a certain quantity of shares like 10, 35, 44, etc. You can only bid for multiples of these shares. The bidding amount falls within a certain range. The higher you bid, the greater are your chances of getting allotted shares. The company then takes into account all the bids by investors and then allots shares.
The price of your bid is not the only thing that decides whether you get shares or not. It depends on the demand for shares too. This is called ‘oversubscription’. In this case, the allotment becomes complicated. Think about it – you have only 100 shares on offer but have bids asking for say, 200 shares. Everyone gets allotted a lower number of shares than they asked for. Some may not even get any shares.
A company’s IPO has to be subscribed a minimum 90%, according to the market regulator, Securities and Exchange Board of India (SEBI). Otherwise, the company cannot get listed on the stock exchange. Underwriters usually buy the remaining shares on offer. These are financial institutions and intermediaries like brokerage firms, investment banks, etc. They are usually paid a commission at the start of the IPO process in exchange for the promise to buy the remaining shares.
Allotment also depends on the category in which you are investing in. If you invest through the Qualified Institutional Buyer (QIB) category, life is a whole lot simpler. Every investor is allotted shares proportionally. The complication happens if you invest as a retail investor. You are not allotted shares proportionally, especially if the IPO is oversubscribed. This is because companies allocate a certain amount for retail investors. That’s the maximum amount of shares that can be distributed to regular investors.
Allotment becomes complicated in the case of retail oversubscription. First, the company totals all the retail bids. It then divides this amount by the value of the minimum ‘lot’. This will give the number of retail investors who will be allotted shares. So if a company offers shares worth Rs 10 lakh and the minimum lot is worth Rs 1,000, then only 1,000 retail investors can get allotted shares. If there are more than 1000 retail investors who have bid, then the eligible retail investors are then chosen by a computer like a draw.
Try to determine the popularity of the IPO. If it is likely to be oversubscribed, then bid on the higher side of the price range. Also, try to bid for a larger amount, say Rs 1-2 lakh, not just the minimum lot. This increases your chances of being allotted shares. Also, investors cannot get allotted shares less than the minimum lot. So it’s better to bid for a larger amount. Of course, if the IPO is oversubscribed by only a small amount, then all retail investors get allotted the minimum amount first. The remaining shares are then allotted for the larger bidders.
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