Don’t let the grey market sway your decision on IPO investing

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Summary

  • In the context of upcoming IPOs, many look to the grey market to gauge investor interest in such stocks

Grey market premium, or GMP, is a very sought-after metric during the initial public offering (IPO) season. In the run-up to the listing of any company, many investors closely track its GMP before deciding on investing in the firm. 

Take the case of Life Insurance Corporation of India (LIC): Its GMP had been negative for the past several days. It  was, therefore, expected to have a tepid listing. And, on Tuesday, the stock listed at 872, an 8% discount to its issue price of 949 apiece. 

So, should you rely on the grey market for any cues? While the GMP proved to be the right indicator for the LIC stock listing, this may not be the case with other firms.

What is GMP?

The grey market is an informal and close-knit market known to operate largely out of places in Gujarat, besides Jaipur, Chittorgarh, Mumbai and Kolkata, where people enter into verbal contracts to buy and sell stocks of companies due for listing at a negotiated price, among other things. In the context of upcoming IPOs, many look to the grey market to gauge investor interest in such stocks. 

Those especially keen on making a quick buck, look to this market to gauge whether a stock will have a bumper or tepid listing. 

For example, a stock that is quoting at a discount in the grey market is expected to have a lacklustre listing, while one trading at a premium can end up with a bumper listing.

For example, if a stock is quoted at 121 apiece in the grey market and its issue price (at the upper end of the price band) is 115, then its GMP is 6 ( 121- 115). But if  it is quoted at 110 apiece, this implies, it is trading at a discount (or has a negative premium) of 5 in the grey market. Information on stock GMPs is typically made available starting from the day of announcement of the IPO price band or sometimes even earlier, and lasts up to its listing. 

In the run-up to an IPO, there is no actual exchange of shares in this market. Trades get settled in cash on listing day after taking into account the negotiated price and the listing price. No trading in unlisted shares of a company (one which has public shareholding) that is due for a public listing is allowed once the IPO prospectus is filed. 

In the case of unlisted companies with no public shareholding, there are no shares to trade with anyways. 

Should you rely on it?

The ‘grey’ market, as its name suggests, is an unregulated market and so, the numbers are hard to verify. 

People we spoke to did not wish to be quoted but suggested that investors base their decision on investing in an IPO on company fundamentals rather than relying on the GMP. According to them, the reasons for this are many. 

One, it is hard to say if the prices quoted in the grey market can be considered truly representative since one cannot know for certain the quantum of trades for different stocks happening here. 

Two, in some cases, the prices may also be prone to undue influence from certain players and, therefore, cannot be relied upon.  One of them suggested that investors must completely discount the GMP in case of smaller public issues. 

Investors can also draw lessons from many past IPOs such as those of Mahindra Logistics, Gland Pharma and SBI Cards and Payment Services, to name a few, where there was a divergence between what the grey market indicated (premium/discount) and how the stock listing went (premium/discount to the issue price).

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