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While the fourth-quarter earnings season was strong, the quality of those earnings was far from impressive.

Now that the majority of earnings have been reported for the fourth quarter, Thomson First Call is projecting year-over-year growth of around 28%, the best showing in more than a decade. But the quality of earnings has deteriorated recently, thanks to a big pickup in "one-time" charges.

Looking at the aggregate per-share results of the

S&P 500

, the difference between "pro forma" earnings

those monitored by Thomson First Call and earnings according to generally accepted accounting principles widened to $2.23 in the just-completed quarter, up from just 56 cents in the first quarter of 2003. GAAP profits for the quarter currently stand at $12.73, while pro forma earnings are at $14.96.

Some companies have contributed more to this trend than others.



, for example, posted GAAP earnings of $6.1 million, or 2 cents a share, in the fourth quarter. But the firm said it earned $61.3 million, or 19 cents a share, when a slew of charges are excluded.

Then there's


( EK), which posted a pro forma profit of 70 cents a share in the fourth quarter. Add back a slew of special costs, however, and the firm's earnings drop to just 7 cents.

Analysts have a tendency to ignore such charges, because they believe that doing so improves the comparability of results from quarter to quarter. But these costs can and do reduce funds available to fuel future growth. What's more, nonrecurring charges have a nasty habit of recurring.

"Incurring several years of these 'one-time' costs, even if unlikely to occur again in the future, may significantly weaken a balance sheet or impair a business in a competitive environment," said David Bianco, head of valuation and accounting at UBS Investment Research.

According to Bianco,

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are high-quality firms.

A high-quality company is one with the smallest difference between historical GAAP and pro forma earnings

or First Call over a specified time, he said.

Bianco conducted a study showing that firms with high-quality earnings typically outperform the market over time, while companies with poor earnings quality generally do not.

Since 1998, the 50 companies in the S&P 500 with the best earnings quality posted an average annual return of 12.3%, while the bottom 50 companies returned zero, he said. The S&P 500 gained 3.3% annually during that period.

A long/short portfolio of these top and bottom companies returned almost 21% annually since 1998, Bianco said. Of the top 50 firms, only three had a negative return over this period, and the average among those was just negative 2.9%. Of the bottom 50, 23 companies had negative returns, with an average of negative 12.2% among those.

"In the past, selecting investments from the top companies, and passing on the investments in the bottom companies, would have provided an investor with significant upside potential, while limiting downside risk," he noted.

Some analysts say investing in high-quality firms doesn't always reap big rewards, particularly over short time periods. Last year, for example, many dubious companies posted huge gains. Pundits also note that historical earnings quality isn't necessarily predictive of future performance.

Still, Bianco said companies that take one-time charges tend to take them repeatedly, "thus making poor historical earnings quality a fairly good indicator of poor future earnings quality."

Despite being burned last year, Merrill Lynch strategist Richard Bernstein continues to favor higher-quality stocks, noting that these companies tend to do better in periods of decelerating profit growth and typically outperform when the

Federal Reserve

is raising interest rates.

"Higher-quality stocks are currently undervalued relative to lower-quality stocks within nearly every economic sector," he wrote in a recent note. "Thus, even sector-neutral investors might benefit from a shift to higher-quality stocks."