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1.
According to the father of value investing, Benjamin Graham, the market could be compared to either a _______.
Voting machine or a weighing machine. A voting machine assesses the popularity of a company, while a weighing machine assesses its substance. Investors tend to treat companies as a voting machine in the short run, but a weighing machine in the long run.
2.
Company A generates $500 million in profits and its return on capital is 10%. Company B generates $250 million in profits and its return on capital is 20%. Which company is more profitable?
Company B. Although Company A generates profits of $500 million, which is greater in absolute terms than Company B's $250 million in profits, Company A has a lower return on capital. For every $1 that investors put into Company A, they get back $0.10 in profits per year. However, for every $1 that investors put into Company B, they get back $0.20 per year.
3.
If a company is unable to pay its creditors back and goes bankrupt, stock shareholders will be first in line to get a claim on its assets.
False. Stockholders will be last to get their claim. Creditors will be in line before them (but after the IRS, of course).
4.
A company's return on capital is calculated by _______.
Dividing profit by invested capital.
5.
All else equal, if a company's total number of shares outstanding is increasing, your ownership stake in that company is _______.
Decreasing. As a company adds shares outstanding, your ownership interest in the firm decreases. Shareholders can benefit more from owning one share of a billion-dollar company that has only 100 shares (a 1% ownership interest) than by owning 100 shares of a billion-dollar company that has a million shares outstanding (a 0.01% ownership interest).