Posted By: Margaret Pozzini

By Motley Fool Staff

Book value is an accounting concept that reflects a company's value according to its balance sheet. It's equal to shareholders' equity, or the difference between assets and liabilities. ADVERTISEMENT
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Book value once approximated a company's market value, as most assets, such as factories and land, were capital-intensive and appeared on the balance sheet. Today, however, as America's economy has become less industrial and more service-oriented, book value is a less relevant measure for investors.

Consider Microsoft, for example. Its recently reported book value was about $36 billion. This is far from a fair value for the company, as Microsoft's market value is around $284 billion, and it has more than $31 billion in cash and short-term investments alone. Much of Microsoft's value stems from assets that don't register significantly on the balance sheet -- its intellectual property, talented employees, strong brand, and phenomenal market share. Also critical are its competitive position and future growth prospects.

Book value can even be a poor indicator of fair value for a heavily industrial company. Imagine a firm that owns a lot of land and many buildings. Over the years, the value of these assets is depreciated on the balance sheet, eventually to zero. But these assets are rarely worthless and can even appreciate in value over time. Such a company might actually be worth a lot more than its book value (while other companies can be worth much less). For these reasons, it often makes sense to largely ignore book value.

Microsoft is an Inside Value newsletter pick.

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