
Underpricing
Underpricing is the practice of listing an initial public offering (IPO) at a price below its real value in the stock market. In any case, the IPO is considered underpriced by the difference between its first-day closing price and its set IPO price. When a new stock closes its first day of trading above the set IPO price, the stock is considered to have been underpriced. An IPO price that reflects a price-to-earnings (P/E) multiple comparable to the company's industry peers is sought. Underpricing is the practice of listing an initial public offering (IPO) at a price below its real value in the stock market.

What Is Underpricing?
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.



Understanding Underpricing
An initial public offering (IPO) is the introduction of a new stock for public trading on a stock exchange. Its purpose is to raise capital for the future growth of the company.
Determining the offering price requires a consideration of many factors. Quantitative factors are considered first. Those are the numbers, real and projected, on cash flow.
Nevertheless, there are two opposing goals at play. The company's executives and early investors want to price the shares as high as possible in order to raise the most capital and reward themselves most lavishly. The investment bankers who are advising them may hope to keep the price low in order to sell as many shares as possible since higher volume means higher trading fees for them.
IPO Pricing Factors
IPO pricing is far from an exact science, so underpricing an IPO is equally inexact. The process mixes facts, projections, and comparables:
Why Underprice?
In theory, any IPO that increases in price on its first day of trading was underpriced, whether it was deliberate or accidental. The shares may have been deliberately underpriced to boost demand. Or, the IPO underwriters may have underestimated investor demand.
Overpricing is much worse than underpricing. A stock that closes its first day below its IPO price will be labeled a failure.
An IPO can be underpriced if its sponsors are genuinely uncertain about the reception that the stock will receive. After all, in the worst case, the stock price will immediately climb to the price that investors consider that it's worth. Investors willing to take a risk on a new issue are rewarded. The company's executives are pleased.
That is considerably better than the company's stock price falling on its first day and its IPO being blasted as a failure.
Whether it was underpriced or not, once the IPO debuts the company becomes a publicly traded entity owned by its shareholders. Shareholder demand will determine the stock’s value in the open market going forward.
Related terms:
Aftermarket Performance and Example
Aftermarket performance is the variation in the price level of a newly issued stock during a period after its initial public offering (IPO). read more
Book Building
Book building is the process by which an underwriter attempts to determine the price at which an initial public offering (IPO) will be offered. read more
Direct Public Offering (DPO)
A direct public offering (DPO) is an offering where the company offers its securities directly to the public without financial intermediaries. read more
Greenshoe Option and Example
A greenshoe option is a provision in an IPO underwriting agreement that grants the underwriter the right to sell more shares than originally planned. read more
Hot IPO
A hot IPO is an initial public offering of strong interest to prospective shareholders such that they stand a reasonable chance of being oversubscribed. read more
Initial Public Offering (IPO)
An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance. read more
IPO Lock-Up
An IPO lock-up is a period after a company has gone public when major shareholders are prohibited from selling their shares, and typically lasts 90 to 180 days after the IPO. read more
New Issue
A new issue refers to a new security, whether a stock or bond, being issued for the first time. IPO's are the most common form of new issues. read more