Get back to the basics with our Foolish back-to-school special! Start your journey here.
Book value is an accounting concept that reflects a company's value according to its balance sheet. It's equal to shareholders' equity, which is the difference between assets and liabilities.
But is it a good measure of a company's worth? Book value once approximated a company's market value, when 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 Motley Fool Inside Value recommendation Microsoft (Nasdaq: MSFT ) , for example. Its recently reported book value was about $31 billion. But that's far from a fair value for the company, given that Microsoft has a market value well north of $250 billion and holds more than $20 billion in cash and cash equivalents 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, for example. Also critical are its competitive position and its growth prospects.
Book value can be a poor indicator of fair value for even a heavily industrial company. Imagine a company 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.