Underpriced IPOs: A Goldmine or Risk? Here's What You Need to Know

Every time an IPO lists at a premium, the same question comes up. Was this a missed opportunity for the company, or a lucky break for investors? In other words, is an underpriced IPO a goldmine or is it a risk disguised as easy money?

The answer depends on how underpricing is understood, because in the primary market, price movements are often mistaken for value long before the business is properly assessed.

In the Indian market, underpricing is often treated as proof of value. A strong listing is seen as validation.

That distinction matters because IPO participation in India has changed. Retail investors are more active than ever. Subscription numbers are widely tracked. Grey market premiums are discussed as indicators. This has pushed issuers to prioritise successful listings over precise pricing.

Underpriced IPO: What It Means and Why It Happens

An IPO is considered underpriced when its shares list on the stock exchange at a price higher than the issue price fixed during the offering. The difference between these two prices represents the immediate gain available to investors who receive allotment. This gap is what is referred to as IPO underpricing.

Underpricing occurs because IPO pricing happens before actual market demand is fully visible. Even with book-building and anchor investors, companies and underwriters must commit to a price without knowing how sentiment, liquidity, or bidding behaviour may change during the offer period. To manage this uncertainty, issues are often priced conservatively.

A lower issue price improves the chances of full subscription and reduces the risk of a weak listing. If demand turns out to be stronger than expected, the adjustment happens on listing day.

Reasons for Underpricing

These are the most common reasons for IPO underpricing observed in the Indian primary market.

1. Subscription Risk

The first fear is simple: the issue may not get fully subscribed. For companies and bankers, this is more than a funding problem. It is reputational. A weak book raises questions that linger long after the listing. To avoid that, IPOs are often priced a little below what demand might support. It is easier to explain a strong listing than a failed one.

2. Market Volatility

Markets move faster than IPO timelines. What looks fair when the price band is set can look expensive by the time bidding opens. Global cues shift. Domestic sentiment turns. Underpricing gives the issue breathing room. If conditions worsen, the price holds. If they improve, the upside shows up on listing day.

3. Information Gaps

Investors do not know IPO companies the way they know listed ones. There is no long trail of disclosures to fall back on. No tested credibility. This lack of information makes investors cautious, even when the story looks strong. Underpricing compensates for that uncertainty. It lowers the psychological barrier to bidding.

4. Investor Psychology

A strong listing changes behaviour. Retail investors feel reassured. Early sellers hesitate. New buyers step in. Liquidity builds. In India, this confidence loop matters more than many admit. A good first impression often buys a stock time — and sometimes that is all it needs.

5. Regulatory Constraints

Price bands, category reservations, and minimum subscription requirements restrict pricing freedom. When flexibility is limited, conservative pricing becomes the easiest option. It reduces execution risk and keeps the process clean.

6. Execution Comfort

This one is rarely written about, but it exists. Book runners are rewarded for smooth outcomes, not perfect pricing. Underpricing reduces last-minute stress. It lowers the chance of intervention. It makes the process predictable.

How Underpricing Is Calculated?

Underpricing is calculated by measuring the difference between the issue price and the price at which the stock begins trading on the exchange. This formula is used consistently across IPO research reports and exchange-level analysis.

Underpricing (%) = (Listing Price – Issue Price) ÷ Issue Price × 100

Underpricing (%) = (325 − 250) ÷ 250 × 100 = 30%

If an IPO priced at ₹250 lists at ₹325, the underpricing is 30%.

This number captures immediate market response. It does not capture future performance, company growth or earnings compound.

Advantages of Underpricing

1. Execution certainty at launch

The most immediate advantage is that the IPO actually gets done without strain. When pricing leaves some room, participation across categories tends to be more even. There is less dependence on last-day bids, fewer uncomfortable moments, and no visible scramble to fill books. That matters because a weakly subscribed category is remembered long after the listing, even if the business is solid.

2. Orderly market behaviour after listing

Aggressive pricing often leads to imbalance. Sellers show up early. Buyers wait. Prices move before the market has had time to settle. Underpricing changes this. It gives trading a little space. Buyers and sellers meet more naturally, and the stock is allowed to find its level instead of correcting itself in public view.

3. Reduced early-stage volatility risk

Stocks that list with a buffer tend to absorb selling pressure better in the first few sessions. This reduces sharp intraday swings and limits panic. In retail-heavy IPOs, that initial calm shapes perception faster than fundamentals ever will. Once confidence is lost early, it is hard to recover.

Sometimes, the first few days decide how a stock is treated for months.

4. Greater participation from long-term investors

Long-only investors usually stay away from tightly priced issues. They do not like entering without a margin for error. Underpricing lowers that resistance. When they participate, trading becomes less noisy, and ownership settles more quickly. It does not show up in headlines, but it shows up in behaviour.

5. Positive implications for future capital raising

The market does not forget how an IPO was handled. When the company comes back for a follow-on issue, a qualified institutional placement, or even debt, investors remember whether the first listing was smooth or strained. Underpricing helps avoid early damage that can quietly increase future capital costs.

6. Simplified execution and reputational protection

Conservative pricing simplifies the process. There are fewer extensions, fewer revisions, fewer interventions. For intermediaries, this predictability is valuable. For issuers, it reduces reputational risk at the first public interaction, when scrutiny is highest, and patience is low.

7. Recognising the opportunity cost

Underpricing means leaving money on the table. Promoters know this. They still accept it because stability, liquidity, and an orderly entry into public markets are often worth more than maximising valuation on day one.

How Investors Can Benefit from Underpriced IPOs?

Investors benefit from underpriced IPOs only if they understand what they are dealing with.

Short-term investors look for listing gains. This works when sentiment is strong and demand is broad-based. It stops working when markets turn cautious.

Long-term investors need to slow down. Underpricing should be treated as a signal, not a reason. A strong debut may justify deeper analysis, but it should never replace it.

Some of the best long-term stocks in India did not have spectacular listings. And some of the most hyped IPOs faded quietly after a few months. Listing-day movements are often driven by noise, while long-term returns are determined by the underlying business.

This is where many investors go wrong. They mistake excitement for insight.

A disciplined approach is to review the company after listing, when the price stabilises, and the noise fades. If the business still makes sense, underpricing can provide a better entry. If not, it is better to walk away.

Conclusion

Underpricing is not the story of an IPO; it is the setting. It shapes how a stock enters the market, how it trades early, and how it is perceived. What follows is determined elsewhere, in execution, governance, and results. Underpriced IPO improves early trading behaviour, support participation from long-term investors, and reduce the cost of a weak debut. These advantages explain why conservative pricing remains common even when demand appears strong. Underpricing is not about maximising the first day; it is about controlling the first impression and buying time for the business to establish itself.

Sources:

Investopedia
Fisdom
IPO Platform