How Does The Stock Market Work? – Part 4

This is the fourth part of our series of understanding how the stock market exactly works. Do read the previous parts (1, 2 & 3) to get an overall understanding of the stock markets. In this part we will be listing B&T Limited on the stock exchanges. 


Now that we have got all the approval for listing, we get a fair idea of how many shares will be offered to the public. This is the shareholding pattern of the company before listing.


Investor Shares Stake (in %)
Billu (Promoter) 5,00,000 26.67%
Tillu (Promoter) 5,00,000 26.67%
Investor 2,50,000 13.33%
VC Firm 6,25,000 33.33%
Total 18,75,000 100%


Our first investor has decided that he will be selling all his shares and the VC firm will also be selling 20% of their holdings, which is 1.25 lakh shares. We get a total of 3.75 lakh shares to be sold to the public. In addition to this, the promoters have decided to raise a fresh capital of ₹500 crore for further growth. After discussion with the investment bankers, they come up with a price band of ₹7495-₹7499 per share. This will be the IPO price band.


Based on the promoter’s requirement of ₹500 crore, the company will have to issue 6.25 lakh fresh shares. This takes the total outstanding shares to 25 lakh (18.75 lakh existing + 6.25 lakh newly issued). Based on the price band, the company is valued between ₹1873.75 crore and ₹1874.75 crore.


On the total outstanding shares of 25 lakh, the earnings per share (EPS) becomes ₹200 (₹50 crore / 25 lakh). Based on the EPS, you get a PE ratio of 37.49 (₹7499 / ₹200) for the upper end of the price band. As you can see, the PE ratio has again undergone some expansion from the previous funding round. 


Our investor who had invested 10 years ago, has made a killing even at a lower price of the price band. According to his holdings, he will be taking home a total of ₹187.3 crore on his investment of just ₹20 lakh! This is what early stage investing is all about. High risk, high reward!


The proposed shareholding pattern after the issue is given below:


Investor Shares Stake (in %)
Billu (Promoter) 5,00,000 20%
Tillu (Promoter) 5,00,000 20%
VC Firm 5,00,000 20%
Public 10,00,000 40%
Total 25,00,000 100%


Out of the total 10 lakh shares available for the public, some part is reserved for retail investors like you and me, some part for HNIs (High Networth Individuals) who invest more than ₹2 lakh, and a remaining part to qualified institutional buyers (QIBs), who you can consider similar to a VC firm.


The investment bankers have set the lot size of 2 shares per lot and applications are to be made in the multiples of this lot. Based on the information, you believe it will be a good company and decide to apply 3 lots (i.e. 6 shares) from your broker. 


Since this was a highly anticipated IPO, for the 10 lakh available shares for the public, the total applications are for 5 crore shares. This means the IPO was oversubscribed by 50 times (5 crore / 10 lakh). If any IPO becomes oversubscribed, the allocation process will be done via a lottery system. 


You were lucky enough to get one lot allotted to you (as compared to the 3 applied). Now these 2 shares get credited to your demat account where all your holdings are stored.


Fast Forward to the day of listing, the market is expecting a bumper listing of B&T Limited, and it doesn’t disappoint. Shares of B&T Limited make a debut on the stock exchanges at ₹12000 per share, a 50% premium over the issue price


Now the trading in B&T Limited starts, and its shares are now traded as any other company in the stock exchange. Some of the people who get the allotment, sell it for a listing gain, while those who didn’t get an allotment buy at a premium to the issue price. You being a long term investor, and believing in the future prospects of the company stay invested, and wait for the price to come back in your buying zone.


In their first year of listing B&T builds a number of new retail stores, and due to that their profits cross the ₹100 crore mark for the first time, which translates into an earnings per share of ₹400. Now that the company is having enough cash to maintain its high growth, the management decides to declare its first ever dividend of ₹100 per share, translating into a dividend payout ratio of 25% (₹100/₹400). Due to the high growth rate and a dividend, the company’s stock has now crossed ₹20000. 


Dividend is a part of profits which the company pays to its investors. 


Years have gone by, and B&T has continued to grow its profits at a higher rate, whilst continuing paying out dividends to its shareholders. As a result of this, the long term investors in B&T have been rewarded handsomely to shareholders.


Similar to B&T Limited, all the big companies like, Reliance, HDFC Bank, Hindustan Unilever etc, also came out with an IPO when they needed money from the public. So this is how the stock market helps both the company (raising money) and the public (participate in the future growth of the company). We’ll learn about the stock market indices in the next article.


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