BROWSE

Underpricing

What is 'Underpricing'

Underpricing is the pricing of an initial public offering (IPO) below its market value. When the offer price is lower than the price of the first trade, the stock is considered to be underpriced. A stock is usually only underpriced temporarily because the laws of supply and demand will eventually drive it toward its intrinsic value.

Explaining 'Underpricing'

An IPO is a newly traded stock on the market and as such it may be newly introduced to investors. The proceeds of its sale are used by the company as capital for funding and future growth. The process for arriving at the offering price includes many factors. Quantitative factors are first considered; however, they are not the only factors that lead to the IPO price.

Firm Financials

The main quantitative factors for valuing an initial public offering include the financials of the firm. Bankers review a firm’s sales, expenses, earnings and cash flow. In an IPO valuation pricing, the company’s earnings and expected earnings growth are key aspects of the price. In general, a company will typically trade at a price-to-earnings multiple that is comparable to its peers in the industry. The price-to-earnings multiple serves as a base level to start from when valuing the IPO price.

IPO Price

Additionally, an IPO may be priced based on marketability factors for its specific industry and the market as a whole. If bankers expect a high demand for the product, that will be factored into the price. Also, if there is a high demand for the IPO market in general at the time of the offering that will also help the price.


Further Reading


Ownership dispersion, costly information, and IPO underpricing
www.sciencedirect.com [PDF]
We develop an explanation for IPO underpricing in which the issuer's demand for ownership dispersion creates an incentive to underprice. Promoting oversubscription allows broad initial ownership, which in turn increases secondary-market liquidity. Increased liquidity …

A simple test of Baron's model of IPO underpricingA simple test of Baron's model of IPO underpricing
www.sciencedirect.com [PDF]
We develop an explanation for IPO underpricing in which the issuer's demand for ownership dispersion creates an incentive to underprice. Promoting oversubscription allows broad initial ownership, which in turn increases secondary-market liquidity. Increased liquidity …

Machiavellian underpricingMachiavellian underpricing
ideas.repec.org [PDF]
We develop an explanation for IPO underpricing in which the issuer's demand for ownership dispersion creates an incentive to underprice. Promoting oversubscription allows broad initial ownership, which in turn increases secondary-market liquidity. Increased liquidity …

Financial wealth, socioemotional wealth, and IPO underpricing in family firms: A two-stage gamble modelFinancial wealth, socioemotional wealth, and IPO underpricing in family firms: A two-stage gamble model
journals.aom.org [PDF]
We develop an explanation for IPO underpricing in which the issuer's demand for ownership dispersion creates an incentive to underprice. Promoting oversubscription allows broad initial ownership, which in turn increases secondary-market liquidity. Increased liquidity …

IPO underpricing in ItalyIPO underpricing in Italy
www.tandfonline.com [PDF]
We develop an explanation for IPO underpricing in which the issuer's demand for ownership dispersion creates an incentive to underprice. Promoting oversubscription allows broad initial ownership, which in turn increases secondary-market liquidity. Increased liquidity …

Litigation risk and IPO underpricingLitigation risk and IPO underpricing
www.sciencedirect.com [PDF]
We develop an explanation for IPO underpricing in which the issuer's demand for ownership dispersion creates an incentive to underprice. Promoting oversubscription allows broad initial ownership, which in turn increases secondary-market liquidity. Increased liquidity …

Equity Separation, Government Regulations, and Chinese IPO Underpricing Puzzle <span style=[J]' src='/thumbnails/?img=http%3A%2F%2Fen.cnki.com.cn%2FArticle_en%2FCJFDTotal-JJYJ200505008.htm' />Equity Separation, Government Regulations, and Chinese IPO Underpricing Puzzle [J]
en.cnki.com.cn [[J]' href='https:/api.miniature.io/pdf?url=en.cnki.com.cn%2FArticle_en%2FCJFDTotal-JJYJ200505008.htm'>PDF]
We develop an explanation for IPO underpricing in which the issuer's demand for ownership dispersion creates an incentive to underprice. Promoting oversubscription allows broad initial ownership, which in turn increases secondary-market liquidity. Increased liquidity …

Real effects of stock underpricingReal effects of stock underpricing
www.sciencedirect.com [PDF]
We develop an explanation for IPO underpricing in which the issuer's demand for ownership dispersion creates an incentive to underprice. Promoting oversubscription allows broad initial ownership, which in turn increases secondary-market liquidity. Increased liquidity …



Q&A About Underpricing


What does a company typically trade at based on comparable peers in industry?

A company trades at a price-to-earnings multiple that is comparable to its peers in industry. The price-to-earnings multiple serves as a base level to start from when valuing IPO prices.

How are quantitative factors used in valuing an initial public offering?

Quantitative factors include a firm's financials, sales, expenses, earnings and cash flow.

What can affect IPO pricing based on marketability factors for specific industries and markets as whole?

If bankers expect high demand for products within certain industries or markets as whole then that will factor into IPO pricing. Also if there is high demand for IPOs overall during offerings then that will also help determine prices.

What is the definition of underpricing?

Underpricing is the pricing of an initial public offering (IPO) below its market value. When the offer price is lower than the price of the first trade, the stock is considered to be underpriced.

Why do companies usually only temporarily underprice their stocks?

The laws of supply and demand will eventually drive it toward its intrinsic value.

How do bankers determine if there will be high demand for IPOs during offerings?

Bankers review how well past IPOs have done compared to their projected performance before going public."