What is Underpricing?

959 reads · Last updated: December 5, 2024

Underpricing is the practice of listing an initial public offering (IPO) at a price below its real value in the stock market. When a new stock closes its first day of trading above the set IPO price, the stock is considered to have been underpriced.Underpricing is short-lived because investor demand will drive the price upwards to its market value.

Definition

Underpricing of an IPO refers to the practice of setting the initial public offering price of a stock below its true market value. When a new stock closes above its IPO price on the first day of trading, it is considered underpriced. This underpricing is temporary, as investor demand will drive the price up to its market value.

Origin

The phenomenon of IPO underpricing dates back to the early stages of stock markets, particularly evident in the U.S. markets during the 1980s and 1990s. During this time, many companies chose to undervalue their stock prices at IPO to ensure a successful launch and attract investor interest.

Categories and Features

IPO underpricing can be categorized into intentional and unintentional underpricing. Intentional underpricing occurs when companies or underwriters deliberately set a lower price to ensure a successful offering and create market buzz. Unintentional underpricing may result from incorrect market analysis or undervaluation of the company. Features include significant price increases on the first trading day and high investor demand.

Case Studies

A classic example is Google's IPO in 1999. Google's stock was priced at $85 at its IPO but rose by 18% on the first day of trading. Another example is Facebook's IPO in 2012, which, despite being highly priced, experienced price fluctuations on the first day, reflecting differing market perceptions of its value.

Common Issues

Investors often worry about missing out on investment opportunities when facing IPO underpricing. A common misconception is that all IPOs will experience underpricing, but this depends on market conditions and the attractiveness of the company itself.

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