When you’re exploring the IPOs in India, you’re bound to come across the term Grey Market Premium, or GMP. GMP often circulates ahead of a stock’s official debut on the exchanges, giving investors a hint at market sentiment and potential pricing of the stock on the listing. But what exactly is GMP, and how should investors interpret it? The concept is broken down to explain its relevance, how it’s computed, and what an investor needs to take into account regarding such a premium.
What is Grey Market Premium (GMP)?
GMP stands for Grey Market Premium, which is an informal measure of the demand and supply for stock before listing on a stock exchange. This is the premium at which shares of a soon-to-be-listed IPO are traded in the unofficial or grey market before their official listing.
The grey market lies beyond the legal ambit of regulated stock exchanges such as NSE and BSE. Instead, it is some kind of an informal network where IPO shares are traded before the actual opening of the IPO. GMP shows the potential listing price since it is calculated based on how much the buyers will pay over the issue price set by the company.
Illustration: Let us take an example of an IPO share issued at ₹100 and sold at a GMP of ₹30. Then the GMP is ₹30. This would imply that the stock will list at about ₹130 (₹100 issue price + ₹30 premium) as per the Grey market.
Why does the grey market exist?
The grey market exists because few IPO shares are highly in demand, which at times can be more than the availability of shares offered to retail investors. This can lead to oversubscription of IPOs, and full allotment cannot be ensured for individual investors. Thus, investors look at the grey market as an alternative source to buy or sell shares before listing.
Besides, GMP provides a signal about potential listing gains. The more the premium, the greater the interest in the company. Conversely, low or negative GMP could indicate no interest by investors.
How is GMP Calculated?
GMP is just demand and supply driven within the informal market. There is no proper calculation or way of arriving at a definite methodology, but here’s a simplified explanation of what happens:
- Demand for shares: The higher the IPO’s demand, the greater the GMP. Investors fundamentally feel that a high GMP means high interest in that IPO and, therefore listing gains would be good.
- Issue Price: It is always compared with the IPO’s issue price. In case a high GMP exceeds the issue price, the optimism of investors is confirmed, while a low GMP may show caution.
- Market Sentiment: General market conditions also impact GMPs. While in bullish markets, the GMP will be more because of optimistic investor sentiments in general.
- Peer Company Performance: Sometimes, if a peer company is doing well in the stock market, then it can act as a positive influence on the GMP of an IPO from a similar company. On the other hand, if negative sentiment is building around peer stocks, then GMP will decline.
There is no official source of GMP data. Investors typically come to know about it from informal sources, mostly brokers and grey market dealers.
How reliable is GMP as an indicator?
GMP is an indicator but not foolproof. Here are some considerations in interpreting GMP data:
- Speculative Nature: GMP is speculative and can change hugely based on rumors, sentiment, and unverified market trends.
- Market Sentiment Driven: GMP is highly dependent on general market sentiment, meaning it is likely to be more reflective of the current environment than the actual fundamentals of the company going public.
- Lack of Regulation: Unlike official stock exchanges (NSE & BSE), the grey market is without regulation, and information that circulates in this market is not subject to the same scrutiny. Thus, misinformation or exaggerated figures might be circulating within the grey market.
What Determines the Grey Market Premium?
Some of the factors influencing GMPs are company-specific and related to its industry; others reflect market-wide attitudes. The main drivers are discussed below.
- Company’s Fundamentals: If the issuing firm is financially sound, has an established business model, and has growth prospects, it is likely to have a high GMP in the pipeline.
- Size and Oversubscription: An IPO that is relatively small in size and gets oversubscribed tends to fetch a higher GMP due to the fact that there are very few shares in the issue. When there is huge demand, the grey market premium increases as well..
- Sector Popularity: If the IPO is in a popular sector, such as technology or renewable energy, the GMP could be higher because of positive sentiment in the sector.
- Anchor Investors: Anchor investors are usually large institutional investors, who help create positive buzz around an IPO, which may enhance the GMP.
- Peer Market Performance: A well-performing peer in the same industry adds to the attractiveness of an IPO, thereby enhancing the GMP.
Should you rely on GMP for making investment decisions?
Investing purely based on GMP is quite risky. A high GMP is an indication of optimism but do not forget the following points:
- Company Research: Never neglect the company’s fundamentals. A good business model, good management, and a strong financial position are much more important than a high GMP.
- Volatility Risks: GMP is highly volatile. If the premium drops close to the listing date, you may end up with less-than-expected returns or even losses.
- Overvaluation Risk: High GMP makes a stock look more valuable than it is. Ensure that the valuation justifies the premium.
- Long-term Strategy: If you are a long-term investor, then you wouldn’t really care much about GMP because it is a short-term listing gain and it does not depict the long-term potential of the company.
Kostak and GMP Rates
Another term commonly heard in association with GMP is Kostak Rate in the grey market. Kostak rate is the premium an investor can earn by selling their IPO application in the grey market before the allotment date. Of course, the rate is relevant to investors who are uncertain about allotment and would like to book a quick profit selling their application.
For instance, if the cost of applying for an IPO is ₹15,000 and the Kostak rate is ₹1,000, then the investor can sell his application for ₹16,000 securing profit regardless of whether the shares are allotted or not.
But just like GMP, Kostak rates too are speculative and may go up and down.
GMP: Risks and Disadvantages
Though helpful, GMP is like a two-edged sword. It does carry the risk of its own kind. A few are given as under:
- Unregulated Market: The grey market is unregulated by SEBI or any other exchange. Thereby, it goes through the least amount of scrutiny and one never finds the genuineness of the information received.
- High Volatility: GMP can swing dramatically, particularly when the IPO listing date draws near. This volatility will have an impact on returns and create uncertainty. The grey market, because of its informal nature, can be vulnerable to manipulation from some players trying to create artificial demand or suppress prices.
- Listing Gains Not Predictable: Despite what GMP may say regarding potential listing gains, there is no guarantee of such. A lot of stocks have defied their GMPs in performance.
Does GMP make a good strategy for retail investors?
The tool could be helpful for retail investors to get an idea of demand. In any case, it would best be used with a better investment strategy. Here’s how you can make the most of GMP data:
- Use as a Sentiment Check: Treat GMP as an indicator of market sentiment rather than a decisive factor. A high GMP might indicate optimism, but it cannot be the sole reason to invest.
- Complement with Research: Look at GMP as part of a broader research strategy. Combine it with the company’s RHP (Red Herring Prospectus) and understand its fundamentals and business model.
- Focus on Long-Term Goals: For those with long-term investments, GMP is not that important. The financial health, competitive position, and potential growth of the company would be of more importance.
Conclusion: To Invest in an IPO or Not-The GMP Factor?
Grey Market Premium gives a preliminary idea of the market’s perception of an IPO. For Indian investors, it has become a widely followed metric for gauging demand. However, relying on GMP without thoroughly analyzing the company’s fundamentals can be risky.
GMP is a predictive indicator and not a confirmative one. Always view the GMP in conjunction with financial analysis and your overall investment goals. This will ensure that while you do benefit from the IPO markets, you are also able to minimize risks.
FAQs
- What is Grey Market Premium (GMP) in IPOs?
GMP is the premium at which shares of an IPO are traded in the unofficial grey market before their official listing on stock exchanges. - How is GMP calculated?
GMP is driven by demand and supply in the grey market. It indicates the price investors are willing to pay for the shares above the IPO issue price. However, there is no calculation methodology for GMP. - What is the difference between GMP and Kostak rates?
GMP indicates the premium for IPO shares before their listing, while Kostak rates represent the profit an investor can earn by selling their IPO application before allotment. - Is GMP a reliable indicator for IPO investments?
Although GMP gives insight into market sentiment, it is speculative and unregulated, making it an unreliable sole indicator for investment decisions. - Where can I get GMP and Kostak rates?
GMP and Kostak rates are usually available informally through brokers, dealers, or online forums. Official platforms do not exist to get the rates. - What are the risks of relying on GMP?
GMP is unregulated, speculative, and volatile, and may not accurately predict listing gains. Overreliance on them can lead to investment risks. - Should long-term investors consider GMP?
Long-term investors should focus more on company fundamentals, financial health, and growth potential rather than short-term indicators like GMP.
Happy IPO Investing!
Related Information & Articles
Current & Upcoming IPOs in India
Types of IPOs: Fresh issue Vs Offer for Sale
8 Important Insights to Decode the Red Herring Prospectus
How to Easily Apply for IPO via UPI in India?
