The Motley Fool Discussion Boards Previous Page Stocks B / Berkshire Hathaway URL:  http://boards.fool.com/you-dont-have-to-do-an-inflation-adjustment-on-30309511.aspx Subject:  Re: Influence on ROE in Investing returns Date:  10/9/2012  5:18 PM Author:  knighttof3 Number:  194782 of 226520 You don't have to do an inflation adjustment on an instantaneous earnings-related rate. A firm with 10% ROE is likely to have 10% ROE the next year with smaller dollars. With a shrunken yardstick you get bigger R and proportionally bigger E as well: the same ratio. I don't think this is necessarily true.E could increase much more slowly (proportionally) due to inflation than R. Let's take an example.Beginning assets = \$100 monetary, \$200 non-monetary (book value with no depreciation). Liabilities = 0.Beginning equity = \$300.No inflation.Earnings = \$100.Ending equity = \$400 (all earnings go to retained earnings.)If we calculate ROE on the average equity, it comes to 2/7 (\$100/\$350) = 28.57%. On the beginning equity, it is \$100/\$300 = 1/3.Now assume 10% inflation (not hyperinflation which will trigger asset re-evaluation and change in equity.)Beginning equity = \$300.Earnings = \$110.Ending equity = \$410.Average equity = \$355.ROE = 110/355 = 30.985% ~ 31%. On beginning equity, ROE = \$110/\$300 > 1/3.If you have to restate assets to \$100 (monetary) + \$220 (non-monetary) = \$320 then your ending equity will be \$320 + \$110 = \$430.Average = \$365. ROE = 30.1369%.Conclusion:IF all net assets (assets - liabilities) are non-monetary AND you calculate ROE on beginning equity AND there is no depreciation, THEN your statement will hold true. In our case, assume \$300 assets = \$300 equity at the beginning, and no cash, and no depreciation charges; then at the end both would be valued at \$330, not counting the recently added \$110 in earnings, and ROE will remain at 1/3 = \$110/\$330.Otherwise, ROE will increase with inflation. Copyright 1996-2016 trademark and the "Fool" logo is a trademark of The Motley Fool, Inc. Contact Us