Overview

Although opening with a quote is a cliché best avoided, this case warrants evoking the perfect maxim. Attributed to Benjamin Franklin, the saying goes, “An investment in knowledge pays the best interest”. While it is great advice, it also serves as a warning to investors looking for the easy way out. There is no “sure thing” in the stock market, except for a trader’s knowledge, research and experience.

Many investors believe that grey markets have come to act as litmus tests for the true price of the stock when it is listed for IPO. In these markets, shares of companies that are yet to open to the public are traded unofficially. Typically, entry to these markets is reserved for those willing to trade in bulk, and the share price is determined at premiums higher than the price offered in the IPO.

While grey market premiums can offer a yardstick against which to trade in the actual IPO, investors should not take these indications as the Word of God. Like any other grey market, the IPO grey market is unregulated, easily manipulated, and may offer pristine market conditions, unlike those of the real market.

Tread with caution

As mentioned earlier, only large trades take place in the grey market. This means that the people participating in these markets are high net worth individuals (HNIs) who go after big portions of the stock offered in IPOs. The quantity of shares they deal in is often more than the part that is reserved for them. By doing so, the overall levels of subscription are elevated, making the shares attractive to investors even at a premium.

Grey markets have earlier proved astonishingly accurate for IPO issues of smaller sizes. Investors participating in these markets tend to be careful when it comes to shares of a new company, while being more forthcoming in their bids for established, quality stocks.

For example, shares of a company are speculated to do very well in its IPO. The listing price is projected to be more than Rs 300 per share in the grey market, which is higher than the IPO issue price. HNIs will be happy to pay handsome financing fees for each share, and the shares may become oversubscribed many times over. However, upon listing, the shares traded are at Rs 200, at a much smaller premium than anticipated. This may translate to mediocre gains for some, while others, who borrow money to subscribe, face losses.

While such a situation is a cautionary tale, grey market premiums have successfully predicted the price of many other IPOs. However, experts and seasoned traders believe that grey markets can be incredibly volatile and illiquid. Therefore, blindly picking up cues from grey market premiums can be dangerous, especially for those looking to make long-term investments.

What to look for instead?

Sure, investors should by all means heed how the grey market reads the tea leaves. However, this should not come at the cost of ignoring the most important factors that determine whether a stock is worthwhile. An analysis of the fundamentals of the company is imperative, no matter how well the future bodes for it.

Investors, especially those looking to make long-term gains, should assess the growth potential of a company. A study into the company’s core products or services and business model can reveal if it has what it takes to remain strong in the long term. The credentials and track record of the firm’s top management, and the achievements it has made under their leadership should also be a factor in deciding whether it is a good investment.

Finally, a fundamental analysis of the company’s financial statements, competitors and external factors is necessary to determine its intrinsic value and financial health. Other than helping determine the share value, this analysis will allow potential stakeholders to acquaint themselves closely with the company.

Conclusion

There are no shortcuts when it comes to building wealth. While grey market premiums may seem like tempting cheat sheets, they are just a small component of the overall due diligence investors must do before committing to a stock. The stock market is unpredictable as is, so additional over-reliance on a single indicator can prove to be detrimental in the long run. In the case of grey markets, this has been proven time and again.