Are you a newcomer looking to invest in the stock market and have been hearing the terminology of “IPO” constantly? An Initial Public Offering is significant when a company decides to sell shares to the public. All of you will want to know how the price of a share is actually decided. This is where the IPO price band concept comes into play.
The IPO price band is an important detail of any Initial Public Offering. It is the method in which your bid will arrive at its final share price, and it’s something every investor should understand before applying for an IPO.
In this blog, we will outline what an IPO price band is, how it works through the book-building stage, and why the price band is crucial to you as an investor.
What is an IPO Price Band?
An IPO price band is the price range in which an IPO applicant can bid for shares of a company in their Initial Public Offering. Think of it in brackets, which consists of the lower and upper limits.
The range will consist of two components:
Floor Price: This is the lowest price that bids can be placed.
Cap Price: This is the highest price, or the ceiling.
For example, if a company announces an IPO price band of Rs. 100 - Rs. 110, the floor price is Rs. 100, and the cap price is Rs. 110, and investors can bid for shares at any price between Rs. 100 and Rs. 110. The cap price cannot be more than 20% above the floor price, according to SEBI guidelines.
Understanding the range is one of the very basic things about investing. If you want to use it as a place to start reading, then take a look at our article, Equity Market Basics, for a more fundamental understanding.
How an IPO Price Band Works?
The primary purpose of an IPO price band is to assist in the book-building process, or price discovery. Rather than have a company decide a set single price, the market or investors do.
Here are the steps:
The announcement: The company and underwriters (lead managers) announce the IPO price band and subscription period dates.
Bidding: During the subscription period, investors are able to bid for a certain number of shares at a certain price, but not to exceed the IPO price band price limits.
Price Discovery: Throughout the bidding period, the underwriters will register demand at each price point. The final issue price emerging from the process will be a function of this analysis of demand to pinpoint the appropriate price with maximum demand.
Cut-off Price: This is the final issue price. Retail investors have the option to place a bid at the "cut-off price", which means they absolutely will accept the final price determined at the conclusion of the bidding period, whatever it is within the price band. This approach will help increase the quota of allotments you may receive for a highly subscribed IPO. Looking for the basics in more detail?
Check out our blog - How to Check IPO Allotment Status Online?
The whole process is fundamentally a methodical way to gauge investor sentiment and ensure the share price is fair and aligned with the demand of the market. This represents the fundamentals alive - the market evaluating the worth of the company.
Who Decides the Price Band of an IPO and How?
The IPO price band is not an arbitrary number. The price band is utilized by the company (issuer) to determine the price with investment bankers and underwriters, looking closely at the market conditions and forces surrounding the initial share offering.
There are a myriad of factors considered to arrive at the right price band:
Company Financials: The company’s financial position (i.e., whether it has debt, what its revenue is, what profit it captured, and what assets it owns) will always be an important consideration.
Industry and Market Conditions: The underwriters will analyze the current state of the market and how the company’s peers are trading, as well as the general sentiment in the economy at that time.
Peer Valuation: The valuation of the peer-listed companies is important to analyze in-depth. For example, if the public company’s competitors have an excess valuation, the new IPO will have a valuation approach that is relative to the peers.
Demand Assessment: The underwriters may talk to anchor investors and institutional buyers in advance to preliminarily assess demand and tailor the price band for the offering.
The entire exercise is complicated. For a more complete analysis of how to analyze the financial health of a company, check out our blog on How to Analyze a Company’s Balance Sheet.
Why is the Price Band of IPO Important?
For investors, the IPO price band is not just a number; it is an establishing point from which research and investment decisions can be made.
It offers a Valuation Benchmark: The price band gives you an idea of what the company and its underwriters feel is fair value for the shares and can be a starting point for your research and analysis.
It Helps You Strategize Your Bid: Understanding the floor and cap price allows you to decide on the bid price. Bidding at the cap price (the “cut-off” mark) gives you a better chance of being allocated shares, especially if it is a hot IPO.
It Ensures Fair Pricing: The bookbuilding process and the price band enable a fair allocation price. Because price is determined by the market as a whole, it isn't skewed or biased by any one group or person. In short, you have less chance of the IPO being ridiculously overvalued or undervalued.
It Guides Investment Decisions: A price band appropriate to the nature of the IPO, and all the other key details in the IPO prospectus, will help you make an informed decision as to whether or not the investment is viable, and fits your own financial plan, this forms part of the wider aspect of fundamental analysis that one undertakes before commencing in the stock market.
Conclusion
The IPO price band is a core concept in stock market investing. It creates the mechanism we call an IPO and fair pricing in discovering an appropriate public market share price. Understanding floor and cap price, how the bookbuilding process works, and what influences your price will allow you to better navigate the IPO market. Always remember, a good investment starts with knowledge. Remember, a successful investment starts with knowledge, and for that, our Stock Market Trading Live Classes are a great resource.
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