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Stocks 105: The Purpose of a Company

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1.
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.
2.
Why does a stock's price always match up so well so soon with the company's performance?
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It doesn't, actually. The keys here are "always" and "so soon." Sometimes the price takes a while to accurately reflect the company's performance. This is due to the market's perception of the value of the company's future profits.
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.
Given that bondholders are always paid before shareholders when it comes to a company's profits, what is the benefit to being a shareholder?
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There are potentially unlimited earnings possibilities. If a company is consistently profitable, the sky is the limit for shareholders.
5.
According to the father of value investing, Benjamin Graham, in the short run the market is like a _______.
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Voting machine. In the short run, the market sees the popularity of a company rather than its substance. A voting machine assesses its popularity.