What is IPO underpricing?
When shares in a company are offered on the stock market for the very first time, this is called its initial public offering (IPO). When these stocks are offered during the IPO at less than their intrinsic value, this is a manoeuvre known as underpricing.
Where have you heard about IPO underpricing?
When large companies announce they are going public, investors are hopeful of underpricing and there will be lots of speculation in the financial news. For instance, eBay shares floated in 1998 at $18, but reached $47.38 by the end of the trading day.
What you need to know about IPO underpricing.
The IPO valuation is based on a ratio of price-to-earnings. Although initial share prices take into account the performance of comparative companies on the stock market, underpricing takes place because the IPO value of a firm can only be quantified by its current financial position, and not its future potential.
This means that market factors, such as intermittent high supply or low demand, can affect the initial value of stocks, even if the marketability of the firm is expected to significantly improve.