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A growing Indian economy and increasing financial literacy in the country have drawn many people’s attention to the Indian stock market. Many people want to invest in the stocks of leading companies and the Initial Public Offerings (IPOs) of listed companies. Many investors only focus on finding ways and tips to double their money. By diverting all their attention towards seeking stock tips and investment ideas, they fail to grasp the basic concepts every investor should know. So, in this blog, let’s focus on understanding a fundamental stock market term, face value.
Table of Contents
Understanding IPOs
Before we understand the concept of face value, we must know what an IPO is since face value applies to IPOs. An Initial Public Offering is the company’s first offering of shares to the public and retail investors. The company can raise capital by offering its shares to the public through an IPO. The process of IPO involves listing of the company on the stock exchanges like the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
That said, the company offers its shares to public investors through IPO at a specific price range. Therefore, public investors, including retail investors, must bid for the IPOs within that price range provided by the company. The lower end of the price band is known as the floor price, while the upper end of the range is called the ceiling price. The company arrives at a value, i.e., the price range, by adding a premium to the face value.
Face Value Meaning
To put it simply, the par value or the face value of the share is simply an accounting term that indicates the nominal value of the share. Companies can issue their shares at a face value of ₹10, ₹5, ₹2, or even ₹1. The issue price or the price band of the IPO is obtained by adding the face value of the shares with a premium the company thinks is indicative of a fair market value.
Therefore, the price band or the issue price is only decided once the face value or FV is determined. After the determination of the face value, the investment banker will calculate the premium the company should ask of its investors. Furthermore, investment bankers will evaluate the company’s current financial records, future business prospects, and estimated cash flows to decide the premium. In other words, investment bankers account for the company’s current sales and profits while also accounting for estimated future sales and profits.
Importance of Face Value in an IPO
So, does the face value only serve as an accounting term that investment bankers refer to while determining the premium of the IPO’s issue price? No, the face value remains relevant even after the company is listed on the stock exchanges. Post-listing, the face value is used to announce splits and dividends.
Announcing Stock Splits
After a company’s IPO is listed on stock exchanges, the price of the company’s stock is bound to fluctuate over time. It may exhibit upward and downward movements based on supply and demand, determined by factors like the company’s performance, the global macroeconomic environment, etc. So assume an event where the company’s share price, with a face value of ₹10, values by ten times post listing in a given period; let’s say from ₹500 to ₹5,000. The valuation is positive, but at a price such as ₹5,000, the stock feels expensive, and fewer retail investors will be able to afford it.
A solution to this is a stock split or a share split; the company would split each share into multiple shares. If the company feels like ₹1,000 would make the share affordable again, it can divide its face value by five and obtain a new face value of ₹2. By doing that, the share trading at ₹5,000 also gets split into five shares so that each share trades at ₹1,000.
In fact, a company with a face value of ₹10 could announce splits in such a way that its new face value could be ₹5 or ₹1 as well. So, if the company finds ₹1000 expensive as well, they could divide the face value by ten and take the share price to ₹500 with a face value of ₹1.
Declaring Dividends
A company may choose to reward its shareholders by distributing a portion of its profits in the form of dividends. When a company announces the dividends it plans on distributing to its investors, it does so with respect to face value. To illustrate, assume a company with a face value of ₹10 and a share price of ₹2,000 announces a 100% dividend. If this is the case, the dividend distributed would be 100% of the face value, which is ₹10 per share.
Conclusion
So, these are the key points you should know about the face value of an IPO. Knowing about the face value helps you better understand dividend distributions and stock splits. That said, it’s crucial that you don’t confuse the face value with other similar-sounding terms like the book value or the market value of the company. So, consider learning and familiarising yourself with such terms to enhance your investing knowledge.