Why You Should Add Back Accumulated Depreciation

We made an extraordinary claim that Wall Street has been using a flawed ROA metric for over a century. The ROA metric which includes the accumulated depreciation distorts the true return on capital and economics of the business because it does not use the original amount money invested in the business.  Investors recognize that the original amount of invested capital is important to know when trying to understand the return on capital, but when using an ROA they tacitly or unwittingly do not use the original amount of invested capital in calculating the return.

Long standing legacies and traditions established as far back as the 1920’s by firms such as DuPont, while brilliant in their day, are flawed and can easily be improved upon.  Analysts sometimes ask the wrong question and confuse sunk costs with post mortem analysis.  While sunk cost is a meaningful concept it must be used in the right context and should not be applied to calculating the economics of business.

Accounting boards such as the Financial Accounting Standards Board (FASB) who govern GAAP, and the International Accounting Standard Board (IASB) who govern IFRS, set standards for financial statements for the purposes of valuing existing assets and for tax reporting purposes, not for stock market investors.

The standard and flawed ROE and ROA calculations are still taught in business schools, the CFA Institute and in the media, allowing the perpetuation of this flawed metric to persist.

We used a simple example of funding an Uber driver to demonstrate how an ROA is a flawed and distorted metric that can be easily fixed by adding back the accumulated deprecation to the Net Assets.

We hope we have put forward enough extraordinary evidence to validate our extraordinary claim that Wall Street has been using a flawed metric for over a century.

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