Investing in an Initial Public Offering does not automatically mean you are getting the shares at a great price.
At the same time, just because you are investing in a sound and stable company, it does not mean you have to pay a very high price for it. It would be a futile investment if the company was excellent but the price of the issue was sky high.
Here's how you can play it safe and ensure you are not duped:
Just Rs 10!
Don't buy an IPO just because the shares are at par value.
Let me explain.
Par value is the face value of the share. This par value is arrived at through an accounting decision and bears no relation to either the intrinsic value of the company or how the public view the company.
For example, the Infosys share has a par value of Rs 5, but it's market price could be around Rs 2,800 per share. When the share is traded in the stock market, however, this value may go up or down depending on the supply of and demand for the stock.
If everyone wants to buy the shares, the price will go up. If nobody wants to buy them, and/ or many want to sell them, the price will fall.
This price is referred to as the market price.
A share with a face value of Rs 10 may be quoted at Rs 55 (market price higher than the face value) or even Rs 9 (market price lower than the face value).
The fact that you are getting shares at par value is no guarantee that the company is going to do well and you are going to rake in big bucks.
Often, most companies come out with shares that are at a premium to their face value. Those that come with shares at face value seem to appear more alluring.
The share price is so cheap!
Some companies whose shares are already available for trading come out with a fresh lot of shares. This is referred to as a new issue or a Follow-on Public Issue -- FPO as against IPO.
A common bait investors fall for is the fact that the price of the new issue is cheaper than the current market price. For example, the current market share may be Rs 100, while the FPO may be offered at Rs 90. Don't let this be the only reason you buy those shares.
Sometimes, the prices of the stock may get manipulated in the market to keep the prices high before a new issue is announced. So, while you think you are getting a good deal because the shares are available at a discount (cheaper) to the market price, the reality is that the market price has been artificially hyped up because of manipulation by brokers.
To continue with the example above, once the issue is subscribed and closed, the market price may drop to even below Rs 90.
It is being oversubscribed!
That does not make it a good investment for you.
The process is that investors have to bid for shares in an IPO. When the bids exceed the number of shares, the issue is said to be oversubscribed.
There could be a number of reasons why this happens.
It could be that many banks and financial institutions are liberally offering loans to apply for the issue. This could result in oversubscription.
Also, institutional investors (as against retail investors like you and me) don't have to put up money upfront when they make their bids. That means they can put in any amount of bids, hoping that the resulting hype about oversubscription will lure more investors.
Be logical
Look at the price independent of the above factors
1. Do you believe in the business the company is in?
2. Does the sector have growth potential?
3. Are you sure you want to be part of it?
4. Are you willing to stay in for the long haul?
5. Are you willing to not get perturbed by temporary price setbacks?
If you have answered yes to the above questions, you are on your way to making a smart investment.
Now, all you have to do is ensure you are getting the shares at the right price. Tomorrow, we shall tell you how to do that.
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