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Comment by tptacek | Hacker News Reader

Prudential's entire market capitalization could be wiped out with $42 billion of unexpected losses

Is this a meaningful comparison? A company's market cap is simply a measure of how many shares it has outstanding and the price those shares command. In what sense does a loss "wipe it out"?

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The relevant thing would be shareholder equity (book value; assets minus liabilities) rather than market cap, in that impairment of assets at a financial firm is supposed to hit shareholders before it hits debt or depositors, that being a pretty major responsibility of equity in financial firms.

Book value doesn't necessarily march in lockstep with market value, which (as you point out) is set by actors' marginal propensity to buy the stock.

A more interesting thing to note would have been that financial firms trading at a marked discount to book value are effectively being judged by the market as being in distress. Financial firms can be analyzed as two things: an operating business and also as a big pot of money. The market is saying "Well, that certainly does look like an attractive pot of money, but you'd have to pay me quite a bit to own that operating business (and the attendant risks of it)."

Unexpected losses on a large life insurance portfolio seem very, very unlikely, absent a mass casualty event (in which case they're likely to get at least partially socialized).

How exactly does a shareholder notice the 'book value' of a company? Sure, they have a 'claim' on a share of that, but that only really matters if the company defaults, in which case it would surprise me if the actual book value is payed back to shareholders.

Perhaps it's also relevant in partial sales of the company?

How exactly does a shareholder notice the 'book value' of a company?

Publicly traded companies are obligated to file quarterly reports which prominently list this number; Googling "$NAME book value" will bring it up for any publicly listed company in the US. A particular retail investor may not notice this, but this is approximately "What is the difference between a number and a string?" for professionals.

In the majority of cases, shareholders don't attempt to extract book value. So-called "value" investors preferentially invest in companies which trade at a discount to book value; this tends to correct trading prices towards it, without the nuclear option of cracking open the company to sell off its juicy innards. (Which does happen, very occasionally, generally via private equity buyouts.)

Obviously, the book value is public and not arbitrary. However, I don't see the direct reasoning behind a "value investor". By that I mean reasoning that doesn't involve guessing what other shareholders will do.

If a company’s considered to be worth $X of money, if you then bundle it with debts worth $-X, the combination should be worth $0.

Ok, but a company's market cap is only a measure of its outstanding equity, not its assets or total liabilities.

Yes, but more precisely it’s a signifier of the market’s belief about the (current value of) future cash flows of the company (for investors) and future price movements of the share (for speculators).

So, if the liabilities exceed the assets by a significant margin, will shareholders trust the company enough for the market value of the share to not move towards zero?

My question is what that number has to do with the ability to absorb a loss (either with assets under management or with reservs or with cash flow). To compare: JPMC has something like $2.5T(!) under management, but a market cap of something like $350B.

It means that a relatively tiny (~1%) forecasting error in the long-term values of assets/liabilities, and how the future might play out, can make or break the company. That means that the predictive model for the future better be very good, and "black swan" surprises unanticipated by the model will have nasty consequences.

While I'm sure a $99B loss would be devastating (after all, it would be more than double the combined insurance claims from 9/11, and close to 3x the combined claims from Hurricane Sandy), it's not at all clear to me how the materiality of that loss relates to Prudential's market cap, which is simply the floating value of all Prudential's outstanding shares.

I keep asking what the connection between market capitalization and significance of a particular loss, and, respectfully, you keep begging the question. "It could break the company". Ok, I mean, that sounds pretty plausible; it would be a world-historic loss. But what is it about Prudential's market cap that makes it one? Market value isn't book value.

The company will be put into receivership when it can no longer meet capital requirements imposed by regulators, this may not be a company breaking event - the receivership proceedings will determine if the insured and creditors are best served by liquidation, conservancy, or rehabilitation.

Assuming a somewhat rational market, a market cap above zero means that the present value of future cash flows is greater than (or equal to) the debts owed. In practice this means the company can borrow against those cash flows, and continue to meet capital requirements - avoiding potential liquidation.

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