The Grey Market is where investors buy and sell companies’ shares (well, no actual sales or purchases are being done, but intentions are made known) before they are officially listed on the stock exchange. And, the Grey Market premium is the amount investors are willing to pay above the speculated price of a company’s IPO.
As an investor, looking into buying the shares of a new company to hold for a long time or looking to buy and exit early, the Grey market is a tempting ecosystem to explore to help make a decision.
But, is the Grey Market Premium an indication of whether or not an investor should be interested in a company?
In this article, I provide answers to the question, as I discuss key issues around why retail investors even watch the GMP, the cons of following the Grey Market for IPO, case studies of successes and failures of GMP-based investing in the Indian Capital market, and finally, my expert verdict.
If you are tracking live IPO Grey Market Premium (GMP) data before making any judgement, you can check today’s GMP of all current and upcoming IPOs on our IPO GMP Today hub page.
Pros – Why Retail Investors Watch GMP
Before we get into whether or not investing based on IPO Grey Market Premium is a good investment strategy, it is key that we understand why retail investors even watch the Grey Market Premium.
You can read our article about the Grey Market and Grey Market premium if you are unfamiliar with it.
Below are a few pros, why retail investors track GMP.
The GMP is a gauge for early demand for a company’s shares.
The GMP of a company’s IPO can be a gauge to measure the demand for the company’s shares. To illustrate:
Company X releases its potential IPO price range as ₹100 to ₹110. On the Grey Market, buyers request allotments and price a unit of the share at 130.
GMP = ₹130 - ₹110 = ₹20.
So, the Grey Market Premium of the company’s IPO is 20.
In simple terms, this means investors are willing to pay 20 over the company's issue price. Investors, therefore, can gauge the demand for the company’s shares based on the GMP. The higher the GMP, the more reasonable it is to assume that demand is high, and the lower the GMP, the lower the demand.
An IPO that reflects this is Canara Robeco AMC, where the GMP was ~12 % above the upper band, and that generated buzz around listing gains.
GMP Helps Estimate Listing Price
Armed wth the knowledge of the issue price of a company’s IPO, and the GMP, Investors can speculate on the opening (issue) price day a company’s shares.
Expected Listing Price =IPO Issue Price + GMP
This gives them an idea of how much exactly they can potentially make. (though not guaranteed).
Feeding of subscription frenzy
A high GMP will attract a high number of investors, which will inadvertently lead to oversubscription, as more investors would want to take advantage of the potential profit guaranteed.
The demand for GMP can also affect the overall opening listing price. It is a loop, however uncertain.
A real-life example is in the case of Airfloa Rail Technology SME IPO, whose GMP surged ~118 % over the issue price.
Cons – Risks of Following the Grey Market for IPOs
The Grey Market Is Unregulated
The activities in the Grey market are unregulated, and out of the jurisdiction of India’s regulatory bodies instituted to watch over the India Capital Market.
In essence, the allotment of shares, intention to buy, and agreement are not legally binding. Any and all parties can rescind the agreement without the risk of facing legal consequences.
The Grey Market Is Speculative and Driven by Hype.
The Grey market premium IS COMPLETELY DRIVEN BY HYPE, emotions, and the will of the players, all of which aren’t really founded on facts.
The listing price determined after bidding is the true reflection of the potential opening listing price of a company’s shares.
The GMP is what players hope they get to gain as an increase in the potential opening price. It rarely means the company’s profits or growth justify it.
GMP isn’t determined by the true reflection of demand for the company’s shares.
The GMP of a company’s IPO might suggest a listing at +20 %, only for the actual opening price to be listed lower than even the listing price determined after bidding.
What this means is that a company can completely underperform.
And why?
Because real forces of demand and supply are reflected in the real market, and not the grey market.
Short-Term Focus
The GMP, if at all it reflects the forces of demand for a company’s IPO, is only for the short term, which is the day of the listing.
Long-term, share prices fluctuate. Hence, the GMP is only useful for the listing day, after which investors allotted can be at risk of not only having bought a stock that rapidly falls.
Case Studies – Success vs Failure of GMP-based Investing
Safe Enterprises Retail Fixtures SME IPO,
Safe Enterprise quoted an issue price of ₹138 (Its Upper band price). The grey market quoted the company’s shares at around ₹148. Hence, its GMP sat at ₹10.
In a case of success, the stock was finally listed on the exchanges, where it opened at ₹151, which gave investors in the grey market a slight profit more than the speculated GMP, and an overall 9.4% premium.
Patel Retail IPO,
The grey market premium of the Patel Retail IPO before listing was around ₹50. This was close to 19.6% higher than the company’s issue price of ₹255. As expected, this generated a lot of buzz and, hence, investor frenzy.
Fortunately, the stock’s opening issue price was at ₹300 on NSE, a few bucks short of the expected projected opening price. In this case, speculation wasn’t quite right. It underperformed, but by a few percentage only.
DSM Fresh Foods (Zappfresh)
DSM Fresh Foods is a rather interesting case study. The GMP ahead of listing was reported to be flat, a rather grim speculation. But contrary to this forecast, the stock was listed at a 20% premium on the listing day. This is one case that proves that the grey market does not reflect the true demand.
Expert Verdict – Use GMP as a Signal, Not a Decision
So, what is my expert verdict? Well, based on the case studies, pros and cons listed in this article, below is my verdict:
- Use GMP as a signal, but not the basis upon which investment decisions should be made
- The grey market is unregulated, and as such, any activity you do in it should be with players you have built trust with. However, not being involved at all is the best decision.
Conclusion
A deeper understanding of how the stock market works is required to become a profitable investor.
The grey market, as explained earlier, can be tempting, especially to new and unseasoned investors, but largely at a very high risk.
Investing based on the GMP is also a fickle thing. The best position to hold regarding everything grey market is to therefore treat it like a signal, rather than being a part of a concrete strategy.
FAQ:
1. Why does Grey Market Premium of IPO often change even when no new information about the company is released?
GMP is based on market sentiment, i.e., the demand from investors. If there is more noise among investors based on the available information, it changes accordingly. It may go up or down based on this noise.
2. If GMP reflects demand, why do some high-GMP IPOs still list below expectations?
As already written, GMP is unofficial and unregulated, and it is only based on expectations. So, while the IPO might have been subscribed very well and the company may have good fundamentals, it can still list out of expectation—either above expectations or below expectations.
3. How can GMP mislead investors during strong bull markets?
In bull markets, investors already have high expectations, and even a small rise in positive sentiment may result in a high GMP. In such cases, GMP may be reported at higher-than-normal levels, which can lead to increased investor participation and lower listing gains.
