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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 201885
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.
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