Course 101: What Is the Purpose of a Company?
Money In, Money Out
In this course
1 Introduction
2 Money In, Money Out
3 The Two Types of Capital
4 Different Capital, Different Risk
5 Returns on Capital versus Returns on the Stock
6 Ownership Interests

Think of companies as machines with two spouts. Investors shovel their money—called capital—into one spout, and the job of the company is to spit money—called profits—out from the other. The ratio of the profit to the capital is called return on capital. The absolute level of profits in dollar terms isn’t nearly so important as profit as a percentage of the capital is.

Take an example. A company may have $1 billion in profits in a given year, but its return on capital might be a meager 4%. It is therefore not a very profitable company. Another firm might generate just $100 million in profits but sport a return on capital of 30%. Now there’s a profitable company. A return on capital of 30% means that for every $1.00 investors have put into the company, the company earns $0.30 in profits.

Next: The Two Types of Capital >>

Print Lesson |Feedback | Digg! digg it
Learn how to invest like a pro with Morningstar’s Investment Workbooks (John Wiley & Sons, 2004, 2005), available at online bookstores.
Copyright 2015 Morningstar, Inc. All rights reserved. Please read our Privacy Policy.
If you have questions or comments please contact Morningstar.