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Stocks 105: The Purpose of a Company

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1.
According to the father of value investing, Benjamin Graham, the market could be compared to either a _______.
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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.
A company's return on stock is calculated by _______.
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Adding capital gains and dividends. This is also known as total return.
3.
Which of the following is a benefit of a bondholder over a stockholder?
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If a company goes bankrupt, bondholders gets paid before stockholders. Stockholders are the "residual" claimants of a company's profits, which means they get paid after everybody else. If a company goes bankrupt, they get what's left over after all the creditors are paid. Bonds typically do not yield higher returns than stocks when a company does well. The government doesn't pay a company's interest on a corporate bond if the company can't pay for it--the company is responsible for the interest payment.
4.
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?
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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.
5.
In return for getting a relatively low rate of return on their bond investments, bondholders enjoy _______ shareholders.
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Less risk than. Besides less risk, they also get an earlier claim on a company's assets should it go bankrupt.