Want to bid for shares? Read this first!

ew things frustate an investor more than applying for shares and not getting them, especially when talk of booming share prices leaves them with stars in their eyes.

A number of my friends have been similarly disappointed.

They simply did not get an allotment after they applied for an Initial Public Offering.

An IPO refers to the first time a company offers its shares to the public. After the shares are alloted through the IPO, the stock will be listed on the stock exchange so that the shares can be bought and sold.

A number of IPOs are in the limelight at the moment.

Since many people apply for an IPO, very few end up with the shares.

Let me explain why this happens and how the IPO game works.

The company will 'discover' its price

Earlier, the company determined a fixed price for the stock issue. The issue was marketed to the general public through advertisements and a media campaign.

Today, companies prefer a book building process. Book building is the process of price discovery. That means there is no fixed price for the share.

Instead, the company issuing the shares comes up with a price band. The lowest price is referred to as the floor and the highest, the cap.

Bids are then invited for the shares. Each investor states how many shares s/he wants and what s/he is willing to pay for those shares (depending on the price band).

The actual price is then discovered based on these bids.

Who can play the game?

Three classes of investors can bid for the shares:

• Qualified Institutional Buyers: QIBs include mutual funds and Foreign Institutional Investors. At least 50% of the shares are reserved for this category.
• Retail investors: Anyone who bids for shares under Rs 50,000 is a retail investor. At least 25% is reserved for this category.
• The balance bids are offered to high networth individuals and employees of the company.

How the game is played

Individuals who apply for the IPO put in their bids.

The process is transparent. You can check on the issue subscription at the BSE and NSE Web sites.

After evaluating the bid prices, the company will accept the lowest price that will allow it to dispose the entire block of shares. That is called the cut-off price.

Let's take an example.

Number of shares issued by the company = 100.

Price band = Rs 30 - Rs 40.

Now let's check what individuals have bid for.

The shares will be sold at the Bid 5 price of 20 shares for Rs 35.

Why?

• Because Bidders 1 to 5 are willing to pay at least Rs 35 per share.
• The total bids from Bidders 1 to 5 ensure all 100 shares will be sold (20 + 10 + 20 + 30 + 20). 

The cut-off price is therefore Bid 5's price = Rs 35.

Bidders 1 to 5 get allotments at that price. Bidders 6 and 7 don't get an allotment because their bids are below the cut-off price.

Go for the higher price band.

As a retail investor, you don't have to specify an exact price.

Make out a cheque for the number of shares you are applying for at the highest end of the price band. If you are applying for 10 shares, the amount wll be Rs 400 (10 x Rs 40 -- the higher end of the price band).

On allotment, the extra amount paid will be refunded to you. Since the cut-off price is Rs 35, the 10 shares will cost you Rs 350 (10 x Rs 35). The balance Rs 50 will be refunded to you.

How the allotment is done

The bids are first allotted to the different categories and the over-subscription (more shares applied for than the shares available) in each category is determined.

Retail investors and high networth individuals get allotments on a proportional basis.

Assuming you are a retail investor and have applied for 200 shares in the issue, and the issue is over-subscribed five times in the retail category, you qualify to get 40 shares (200 shares/5).

Sometimes, the over-subscription is huge or the issue is priced so high that you can't really bid for too many shares before the Rs 50,000 limit is reached.

In such cases, allotments are made on the basis of a lottery.

Say a retail investor has applied for 5 shares in an issue, and the retail category has been over-subscribed 10 times, the investor is entitled to half a share.

Since that isn't possible, it may then be decided that every 1 in 2 retail investors will get allotment. The investors are then selected by lottery and the issue allotted on a proportional basis among.

That is why there is no way you can be sure of getting an allotment.

How to make an allotment work for you

Put in bids in the names of your family members. The problem is, you will need to open demat accounts for them first.

Most regular IPO investors try to calculate how much the issue will be over-subscribed and then put in their bids accordingly.

For instance, if you want 10 shares and feel the retail portion of the issue will be over-subscribed three times, you should bid for 30 shares.

You could also apply separately in the high networth category if you have the money.

Illustration: Dominic Xavier