How is an IPO Priced?

The process of a company being listed on one or more stock exchanges is known as an IPO. It is very important to get an IPO Priced. The company’s ownership is diluted after the IPO. The company’s owner determines how many shares they wish to sell in the IPO throughout the application process. It then hires a merchant banker to assess its financials, business prospects, major risks, and management style in order to decide the IPO Price.

An IPO’s pricing is typically established in one of two ways: a book building offering or a fixed price offering. The merchant banker establishes a pricing range, also known as a price band, in a book building offering. On one side of the price band is the floor price, and on the other is the cap price. As a result, a book-building IPO price may range from $100 to $110. At the time of application, investors can choose the number of lots they want and the price. A fixed price offering has a set price, and investors must pay the full amount up advance.

How is an IPO Priced?

How is an IPO Valued?

When a private firm offers shares publicly for the first time in the stock market, it is known as an initial public offering, or IPO. When a firm launches an IPO, the stocks cease to be private and become the property of all shareholders.

The private corporation becomes public for two main reasons:

  1. To raise finances for growth
  2. To get out of debt or recover from losses

IPOs with a solid corporate profile and market capitalisation are often valued by shareholders. Potential shareholders consider both aspects before making their decision.


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What do IPO Valuation Components Include?

An IPO is governed by supply and demand principles: the larger the demand for the company’s shares, the higher the price. Other considerations such as industry comparable, growth potential, and the company’s corporate story, in addition to demand, play an equal influence in setting the IPO Price.

The following is a breakdown of each component:

Demand

The term “demand” relates to how important an IPO is to investors. Paytm launched the world’s largest initial public offering (IPO) in early November 2021. The IPO was priced at INR 2,150 with an issue amount of INR 18,300 crore (US$ 2.47 billion). The issue received 1.89 subscriptions. The company was, however, listed at INR 1,950, a 9.3% decrease to its IPO price. This demonstrates that demand is rarely a reliable measure of a company’s worth. However, before investing in an IPO, investors frequently consider the demand.

Industry Equivalents

Investors will compare the company’s valuations to those of its listed competitors if the company launching an IPO has several competitors already listed on the bourses. They may not invest in the IPO if they believe it is expensive and too distinct from its competitors.

Potential for Growth

The IPO price is also heavily influenced by a company’s growth prospects. Companies typically raise funds from the market to fund their business plans and expand. If a company’s primary goal in going public is to restructure debt, however, the values may be relatively low. Investors want companies with a proven track record of growth. Additionally, companies that show their progress clearly may pique investor attention.

Narrative of the Industry

The IPO price is sometimes influenced more by the industry narrative than by quantitative statistics. The COVID-19 epidemic, for example, thrust the pharmaceutical business back into the spotlight. This can boost a pharma company’s initial public offering (IPO) valuation.

What are the IPO Valuation Methods?

IPO valuation is a difficult task that requires the expertise of qualified merchant bankers and financial specialists. Because the Securities and Exchange Board of India (SEBI) considers every detail before issuing a green signal, this phase is critical.

The following are the most common methodologies used by merchant bankers to determine the IPO price:

Relative Assessment

In this strategy, the merchant banker examines the valuations of companies that have already been listed and determines the optimal price. Price to earnings ratio, cash flow, and earnings per share all play a role here.

Absolute Assessment

The merchant banker uses the Discounted Cash Flow (DCF) method to evaluate the company’s financial position and strengths in this system. Absolute valuation, unlike relative valuation, considers the company’s actual wealth and interest in determining the price.

Cash-Based Discounted Valuation

Many financial specialists work together to assess the company’s predicted cash flows, potential income sources, and future performance potential, among other things. Because an inaccurate estimate might boost or reduce the company’s valuation, this method is more difficult than the relative or absolute valuation methods.

Economic Assessment

The merchant banker uses the Economic valuation method to look at things like business residual revenue, debt position, the net value of assets possessed, and more.

The Consequences of a Public Listing

Although there are advantages to going public, there are also significant disadvantages to consider. An IPO might take anywhere between six months and a year to complete. During this time, the company’s management team is likely to be focused on the IPO, putting other elements of the firm at risk.

The Securities and Exchange Commission (SEC) oversees public firms in the United States. Thousands of shareholders make up public companies, which are subject to rules and regulations. A board of directors must be established, and quarterly financial and accounting data must be auditable.

Going public is a costly procedure, which is why only private companies with good fundamentals and great profit potential have gone public in the past. Finally, a public company’s information is freely available online, which may be valuable to competitors.

Conclusion

It’s all about selecting on the valuation of the IPO rather than the share price when deciding which one to invest in.

Once a stock is listed on the stock exchange, it is affected by a variety of factors such as general market sentiment, economic situations, natural disasters, and so on.

Before investing in an IPO, investors must carefully examine prior performance, financial statements, history, trends, fundamentals, and several other key characteristics.