IPO stands for Initial Public Offering. This term describes the first ever time a company’s shares enter the market and are available for members of the general public to buy. It is somewhat similar to a grand opening party where everybody is invited to come buy a piece of the company. But just how do you decide what price to pay? That’s where the cut-off price comes into play.
What is Cutoff Price in IPO?
The cut-off price refers to the final price at which shares are alloted to the investors. It is the price comparable to that of the outcome after the book-building process, in which investors bid for shares within a specified price range. Imagine it’s some sort of auction where the bidders, in a way, determine the final price based on demand.
For instance, if a company indicates the price band of 100-150 INR per share, investors will bid within that. The company will then look at all the bids and decide the cutoff price, which is essentially where it can sell the maximum number of shares without actually selling them for less than they are worth. This usually tends to be at or near the upper end of the price band.
Why Is the Price Cutoff Important?
For making an intelligent IPO investment, one must grasp the concept of price cutoff. Here is why:
Allocation of Shares: Those who bid at or above the cutoff price are given shares. If you place a lower bid, you miss this. It would be like buying concert tickets—indeed, the nearer to the first row, the higher the price you will have to pay.
Reflects Demand: A high cut-off price is indicative of investor demand for the IPO, and a lower one may mean that there is less demand. This gives you a feel for just how popular the company is among investors.
Maximizes Proceeds: The cut-off price allows a company to realize proceeds from its issue of shares. This assures that money is not left on the table by selling the shares too cheaply.
How to Approach any IPO Investment with Cutoff Price in Mind
Now that we know the cutoff price and why it is relevant, let us get into how you may put this information to practice for your better investments in any IPO.
Bid at the Cutoff Price: Very clearly, bid at the cutoff price to increase the chances of receiving an allotment. While bidding, you might see such an option called the “cutoff price” in the bidding window. Do so, and you have indicated that you are willing to pay whatever the final cutoff price comes to be.
Research and Analysis: Before you go into the bids, research about the company. Look at their financials, go through the market position carefully, and evaluate the looking growth potential. In the case of a company that is highly anticipated, the cutoff price might be at the higher end of the range.
However, you can add that if one finds that a company is under pricing its shares, one may choose to bid at the higher end of the price bandwidth the company is proposing.
Risks and Considerations
While deciding on the cut off price is important, there are certain risks and considerations that are inherent to this step.
Overvaluation: Just because there is enough demand in a company’s IPO, it doesn’t mean that it’s a long-term investment. Overvaluation can occur in case the cutoff price is at a high level. Of course, as always, look at the company’s fundamentals and long-term prospects.
Market conditions: The overall stock market conditions can affect the cutoff price. In a raging bull market, cutoff prices tend to be higher due to the higher investor enthusiasm.
Reallocation Risks: In an IPO, you do not get what you apply for at the cutoff price, mainly when it is an over-subscription issue.
Example:
Suppose you are looking to invest in a tech company that is coming up with an IPO; your application price bracket in circulation is 200-250 INR / share. On the other hand, you have faith in the potential of the company and will make an application at the cut-off price. The company decides to set the cutoff price of 245 INR per share due to the overwhelming demand seen in the book-building process. Since you have bid at the cutoff price, you are likely to get an allocation, whereas those who have bid at a lower price will not.
Conclusion
So, we have covered what is cutoff price in ipo and other key details. Whenever somebody approaches the investment in the primary market, the cut-off price will be necessary for a detailed research to make an informed decision. An eye on the cutoff price and a little consideration toward the fundamentals of the company will really be able to prepare you better in making wise investment calls.Â
