Could IPOs actually cause the stock market to drop instead of rising? While initial public offerings (IPOs) are often seen as exciting opportunities, they can sometimes spark significant market drops. In this article, we’ll break down how the launch of new stocks can influence the broader market, with real-life examples and easy-to-understand data demonstrating how these events can impact investors, stock prices, and entire sectors.
Initial Public Offerings (IPOs) are generally considered a major milestone for companies seeking to raise capital and offer investors the chance to profit from emerging businesses. However, IPOs can have a big impact on the overall stock market, especially when well-known IPOs change how money flows in the market, how investors feel, and how different sectors perform. This article will explore how IPOs can contribute to a stock market fall in India, using recent examples, data, and charts to illustrate this phenomenon.
1. Liquidity Drain and Short-Term Market Sell-Off
One of the primary ways IPOs influence the stock market is by draining liquidity. When investors funnel money into IPOs, they often liquidate existing holdings in the market, causing a short-term sell-off. This effect is amplified during large IPOs that generate substantial attention.
Example: LIC IPO (2022)
The Life Insurance Corporation (LIC) IPO, which raised ₹21,000 crore, was the largest in India’s history. However, its massive size raised concerns about liquidity. During the IPO subscription period (May 4 to May 9, 2022), Indian stock indices, including the Nifty 50 and Sensex, experienced declines as funds were redirected towards LIC shares.
Impact of LIC IPO on Market Indices: A Closer Look
LIC IPO Size: ₹21,000 crore
Opening on May 4, 2022:
The Nifty 50 opened at approximately 17,096 points.
Closing on May 9, 2022:
The index closed at around 16,301 points. Overall Decline: This represents a drop of about 794 points, or approximately 4.6%, over the five-day period.
This drop in the Nifty 50 shows how liquidity was drained from the market to fund the LIC IPO subscription.
2. Overpricing and Negative Market Sentiment
IPOs that are overpriced can trigger negative sentiment in the market. If the IPO price fails to deliver expected returns, investors’ confidence can wane, affecting related sectors and stocks.
Example: Paytm IPO (2021): The Paytm IPO (One97 Communications) raised ₹18,300 crore, but the share price of ₹2,150 per share was deemed too high by many analysts, given Paytm’s unproven profitability. Upon listing on November 18, 2021, the stock dropped 9%, and by November 30, 2021, it had fallen by 27% from its issue price.
Paytm’s Disappointing IPO Journey: A Sharp Decline from Issue Price
Paytm IPO Issue Price: ₹2,150
It was listed at ₹1,955, marking a 9% drop from the issue price, and later fell by 27.25%, reaching ₹1,564 during the trading day.
This underperformance had a ripple effect, causing a broader sell-off in the fintech and tech sectors.
3. Sectoral Rotation and Impact on Related Stocks
When large IPOs happen in specific sectors, investors may rotate their portfolios, moving money out of stocks within the same sector to participate in the IPO. This can lead to declines in related stocks.
Example: Nuvoco Vistas IPO (August 2021)
In August 2021, the Nuvoco Vistas IPO, a cement industry player, triggered a sectoral rotation. Investors sold shares in established cement companies like UltraTech Cement and ACC Limited to participate in the IPO, leading to a decline in the stock prices of these companies. This shift in funds towards Nuvoco Vistas highlighted how IPOs within a specific sector can cause investors to redirect capital, impacting related stocks in the same industry.
4. Timing Amid Volatility and Broader Market Conditions
The timing of an IPO can significantly impact its effect on the stock market. If an IPO occurs during a period of market volatility, it could worsen existing market declines.
Example: Hyundai Motor India IPO (2024)
The Hyundai Motor India IPO (2024) faced challenges due to global volatility and rising interest rates.
Issue Size: ₹27,870.16 crore (~$3.3 billion)
Price Range: ₹1,865 to ₹1,960 per share
Listing Performance: 1.33% drop (₹1,934) and a 6% decline on debut, closing at ₹1,820
The IPO’s poor debut and broader market declines highlight the risks of launching in volatile conditions, stressing the importance of timing.
5. Institutional Investors and Portfolio Rebalancing
Institutional investors, like mutual funds and foreign institutional investors (FIIs), often participate heavily in IPOs. To free up capital for these investments, they may sell off stocks from their existing portfolios, temporarily dragging down the broader market.
Example: Coal India IPO (2010)
IPO Size: ₹15,200 crore (~$3.4 billion)
Issue Price: ₹225 to ₹245 per share
Subscription: The IPO was heavily oversubscribed, with strong participation from institutional investors.
– Impact on the Market:
To raise funds for participation, institutional investors sold off stocks in other sectors, which resulted in a temporary 3% drop in the Nifty 50 during the IPO period.
Nifty 50 Decline: From 6,122 (October 18, 2010) to 5,982 (October 19, 2010), a drop of around 3%.
This drop was attributed to the rebalancing of portfolios by institutional investors, as they adjusted their holdings to make room for the new investment in the IPO.
Conclusion:
While IPOs are celebrated as gateways to new investment opportunities, they can also stir up short-term turbulence in the stock market. Factors like liquidity drain, overpricing, sector shifts, and market timing can contribute to unexpected market drops. Investors must carefully assess the timing, pricing, and market conditions before making decisions. Proper research and consultation with financial advisors are crucial to understanding the potential risks and rewards. Ultimately, while IPOs present opportunities, they can also disrupt market dynamics, making it essential to approach them with caution and strategic foresight. Be prepared sometimes, the thrill of new listings can come with a market dip!
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The article is authored by Ms. Aarti Wadhwa from Team RichVik.