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The following piece was printed in "The Fleet Street Letter," a prestigious subscription only publication that is purchased by most top investment companies.  The article appeared in February 2000 and is input here because The Fleet Street Letter does not maintain an archive on its web site.  Subscriptions to this publication can be ordered at

Is America's Most Widely Held Stock A Pyramid Scheme

I'll have to admit right away that what you're about to read is hard to believe.  The sheer claim that Microsoft's reported profits are nothing more than a vast pyramid scheme designed to rob America's pension and retirement funds is remarkable.

Controversy surrounds Microsoft.  But whether you like the Windows operating system or not, whether you like Bill Gates or not, or whether you think Microsoft has "monopolistic tendencies" or not, one thing has never been publicly doubted about Microsoft: its profitability.  But that's exactly what I'm calling into question here.

Much of what you'll see here is taken from the research of Bill Parish, a financial advisor from Portland, Ore.  you can visit his web site and download his report at  I encourage you to do so.  He has done extensive research into this matter and met with much resistance.

I spoke with Mr. Parish on the phone recently, and while I'm not a CPA, I found much of what he said is plausible.  What's particularly interesting is that none of the reporters who've written articles on Parish's report have included his web address.  Nor have they included any of the graphics or statistics from his web site.

No Accountability

Parish claims that Microsoft is misreporting earnings by not properly accounting for the stock options it issues as compensation to its employees.

Here's how it works.  To attract and retain employees - its knowledge capital - Microsoft issues generous amounts of stock options rather than paying real wages.

Wages are a cost.  They show up on a balance sheet, affecting net income and, eventually, earnings and profitability.  Knowing that showing consistent earnings growth is key to sustaining higher stock values, it becomes imperative for Microsoft to ensure that high wages do not show up on the balance sheet as a cost.

When an employee exercises stock options, the options are valued at the current market price of the stock, less the exercise price of the option.  The difference between the two is the gain realized.  The employee must then report this gain as income and pay tax on it, even if the stock is not sold.

But the employer, in this case Microsoft, takes a tax deduction for the wage expense of the same amount.  In 1999, Microsoft took a tax deduction in excess of $9 billion for this wage expense.  None of that, however was charged to wages.

In other words, Microsoft is taking a tax deduction for wage expense without charging (i.e. reducing) its earnings at the same time.  if Microsoft had charged its earnings for this wage debt in 1999, it would have reported a net loss of close to $3 billion.

Obviously, rather than meeting or beating analysts expectations on an earnings per share basis, Microsoft would be losing money.  But this challenges everything that's publicly perceived about Gates and his company.  Microsoft is one of the only profitable companies in the tech, Net and software industries, isn't it?

According to Parish, absolutely not.  What's more, Parish points out that this questionable accounting practice has begun to siphon off funds from the retirement system.  Keep in mind, this isn't a question of value at all.  If investors want to pay for an overvalued stock, that's fine.  The market will work that out in time.

But by overstating earnings, Microsoft also poses a threat to billions of retirement dollars pouring into indexes which are modeled on the S&P 500, or any index which mirrors the S&P 500, goes toward the purchase of Microsoft stock.  Inflated earnings make the company more profitable, fueling interest in the stock even more, and rewarding Microsoft with a market value over half a trillion dollars.

So, if Parish's analysis is correct, Microsoft has taken the true cost of running its business off the books.  It's outsourced its compensation to the stock market, creating the need for an ever larger growth in liquidity to pay employees from shares of stock without giving up too much ownership of the stock.  It has inflated net income, fueling interest in the stock and boosting the value of the shares.

What Does This All Mean For Investors?

It means converting knowledge capital and intangible assets into quantitative figures that you can make decisions on is perilous at best.  In the case of Microsoft, if Parish is right, bad accounting practice is actually defrauding investors.

Ultimately though, it means that as an investor, you have to decide if you will base your decisions on assets whose value are as yet unknown by the market.  And you put yourself at the mercy of an increasing number of businesses that are deliberately misstating earnings to try to attract investors in an increasingly competitive stock market.

Or, will you try for something more tangible... say ...particle board?  We've chosen to give you the Microsoft example, and the pick on the next page, to remind you that while numbers don't tell you everything, they can tell you a lot about a business. And rather than trying to guess which companies have genuine intangible assets and which are frauds, we'll stick with doors and furniture.

Bill Parish
Parish & Company
10260 SW Greenburg Rd., Suite 400  Portland, OR  97223
Tel:  503-643-6999  Fax: 503-221-3161  email:

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