IPO stands for initial public offering, a process by which a company can offer its shares for sale on a stock exchange for the first time. An IPO enables retail investors to take a stake in the company – turning it from a private enterprise into a public one.
Businesses undertake IPOs to help them raise capital by selling stock to public investors. Listed companies tend to be subject to far more rules and regulations than private ones, though, so getting a business ready for an IPO can be a lengthy process.
Once a company is ready to list, it will decide how many shares it wants to sell. It will then work with an investment bank to set an initial price for those shares and begin the selling process.
IPO underpricing meaning
IPO underpricing is the term for when the investment bank underwriting an initial public offering prices the shares lower than their market value. In an underpriced IPO, the shares will be above their IPO price at the end of the first day of trading.
In 1998, for example, eBay shares were priced at $18 in its IPO. By the end of the first trading day, those shares were worth $47.38. Its IPO was underpriced by $29.38.
An IPO may be underpriced for multiple different reasons. The underwriter may deliberately value the shares lower to increase demand, for example. Alternatively, they may underestimate how strong demand is.
The opposite of underpricing is overpricing, which occurs when a stock drops below its IPO price on its first trading day. In this instance, the IPO is generally considered a failure, which may have longer-term ramifications for the company on the market.