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Home / Opinion / Views /  Zerodha co-founder on grey market premiums: Are they larger than life?

The thing to note is that before getting listed, these IPOs trade at a secondary/grey market that a unique opportunity to view what the listing beholds. The usual scenario is them trading at some premium that strives to mirror market receptivity for the concerned stock. Within the 90 days of 2021 so far, a total of 16 companies have raised money from the Indian capital markets through the route of an IPO. To give you some perspective, in the year 2019, 16 companies in totality had gotten listed. The issue size for the year 2021 exceeds that of 2019 by a whopping 2,314 crores. Having said that, one also needs to factor in the havoc brought about by the Covid-19 pandemic in 2020. This naturally de-railed plans for a multitude of companies who were aiming to list in the concerned year.

While it’s exhilarating to see new ventures getting listed on the exchange, market participants must approach them in a pragmatic manner. Talking about approaches in the context of IPOs, Grey Market Premium (GMP) is a widely used parameter, primarily by retail investors to evaluate the prospect of a particular name. Before moving any further let’s understand the concept of GMP. For instance, if a company’s issue price is 100 and the grey market premium for the same is 15, it indicates that market participants are willing to purchase these shares for 115. In other words, the company is dictating a premium of 15%. It is imperative to bear in mind that the premiums are indicative in nature and do not reflect the actual price to a T.

If one does the math, grey market premiums and listing gains are strongly correlated. However, a higher premium does not ensure higher returns for investors in a long-term scenario. Let us understand this with the help of an example. The grey market premium as a percentage of the issue price for MTAR Technologies Ltd. was 92% and the same for Hernaba Industries Ltd. was 43%. Subsequently, their listing gains were 89% and 44% respectively. Now, the catch is with the subscription numbers. While the former was subscribed almost 200 times, the latter was subscribed to the proximity of 83 times. Therefore, the basic argument is that on a net basis, a retail investor is in no position to generate outsized returns from the disparity.

To further materialize this idea, let us have a look at a two-year-old IPO, Ujjivan Small Finance Bank. It got listed on the exchanges on December 12, 2019. It enjoyed a handsome listing gain of 51% on the very day. However, as of April 1, 2021, it is trading at the bourses below its issue price. That bears testimony to the fact that it is not too rewarding for an investor to base his/her decision on the GMP numbers. In stock markets and life otherwise, it is essential to have a set of rules and play by it. The more you tamper with the former, the more complicated your outcome begins.

As far as my reckoning is concerned, there are a few fundamental aspects that shall ideally command one’s decision to apply for an IPO-

a) Business moat is your true premium: The foremost thing that you should look out for is the quality of the business and subsequently if there is any competitive advantage for them. A good quality company may not command handsome listing gains on the very day but might be a worthy pick for a longer-term horizon. Likewise, for a poor-quality name. Hence, understanding the business is of paramount importance

b) Sector is the broader vessel: There needs to be a careful assessment of the sector in which the company is operating in. I often mention that the ones who gauge the prospects of a sector and catch it at the inflection point are bound to be outliers. Make a calculated guess around the future of the space and take a call

c) Myopic vision cuts your upside: The reason I say that is because of the glorified idea of listing gains. No doubt it works for a few stocks and it shall continue to, but the idea is to hold on to the prospective outliers. It is necessary to zoom out from the quick buck intention and have a broader horizon

The IPO appetite that we are currently witnessing from the context of the Indian markets is a positive sign. New and diverse companies not only bring in opportunities for investors but also add diversity to the market. The idea is pretty straight-forward. And that is to keep things simple. More often than not we fail to recognize the opportunity cost of a missed trade. In stock markets, it’s not the ones who do not know lose out, it’s the ones who get to know late do. Irrespective of all the analyses that you do, the thing to keep in mind is-

‘Price is what you pay, Value is what you get’, Warren Buffet.

Nikhil Kamath, co-founder and CIO, True Beacon and Zerodha

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