Accounting for One-Time Gains and Matching the DOT

Also, why has the Russell 2000 been rising lately?
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First up this week is

Jeff Weber

, who writes: "When a company reports earnings, do they claim the proceeds from the sale of businesses that they own as revenue contributing to earnings per share? For example, does the sale of

Delphi Automotive Systems

contribute to

General Motors'

(GM) - Get Report

earnings? If

Compaq

(CPQ)

sells or spins off

AltaVista

would that add to their EPS?"

Jeff, that would be a "yes" with a "but." Yes, one-time gains from the sale of operations do inflate earnings per share, but this inflation should be clearly noted within the income statement. Take the case of

Ford's

(F) - Get Report

latest quarterly report. Ford reported earnings of $1.60 a share on net income of $1.98 billion. But Ford got $165 million of that $1.98 billion when it sold its stake in Portuguese minivan manufacturer

AuroEuropa

to joint venture partner

Volkswagen

. The company notes that one-time gain in the footnotes to its income statement, and provides an adjusted figure of $1.46 a share, which we can then compare with Ford's performance in previous quarters.

Legitimate companies are not in the business of deceiving shareholders by pumping up earnings on the sly, for a couple of reasons: First, it's a short-term business that tends to end badly. Take a look at what book-cooking did for

Cendant

(CD)

. Second, and more importantly, inflating earnings goes against the credo of every self-respecting lazy American: Don't do too good a job today, or people will expect the same tomorrow. Inflating earnings with one-time gains would only make sense if a company never planned to release another earnings report, since subsequent quarters would give the impression of decreasing earnings momentum. Much more common, in fact, is the practice of artificially

depressing

earnings with huge one-time charges, giving the impression that business is ramping in the coming quarters.

All this is not to say that you shouldn't be scrutinizing income statements. Far from it -- such scrutiny is what allows us to make distinctions between legitimate and illegitimate companies in the first place. Click

here to watch

TSC

Senior Writer

Alex Berenson

put

USA Networks'

(USAI) - Get Report

1998 income statement through the wringer.

Message Center

Memo to

T. Clark

, who wonders whether if the

Russell 2000

has been rising lately because it's been adjusted for Internet stocks. It's more likely that it's been rising because it

hasn't

adjusted for Internet stocks. First of all, the rebalancing of the

Russell -- that is, the reconstitution of indices to account for changes in companies' market capitalizations -- doesn't happen until June 30, too far in the future for tracking funds to be re-coordinating their portfolios. (

TSC

covers the rebalancing every year; click here for

last year's piece.) And when rebalancing happens, the stocks to watch are those entering the Russell, rather than highfliers like

CMGI

(CMGI)

and

E*Trade

(EGRP)

, who'll be taking their huge momentum out of the index.

Memo to

Walter

, who wonders how he can construct a portfolio matching the

TheStreet.com Internet Sector

index: There are two very easy ways I can think of, Walter. You could just simply buy the index's component stocks; there are 20 of them, all evenly weighted. (You can find them

here.) The other option is just that -- play the options. Decide how bullish you are on the sector and buy some DOT calls on the

Philadelphia Stock Exchange. Remember, DOT options are cash-settled, meaning that if you exercise a call, you get the cash difference between the index level and your strike price.

Memo to everyone who responded to

last week's plea for searchable databases of short interest: Thanks. I got peppered last weekend with about 25 emails recommending a database put together by

ViWes Web Services. Though it's not searchable in the strict sense, it parses data on short interest in several useful ways. The catch: It only includes

Nasdaq

stocks.

Still looking for something better than

The Wall Street Journal's

short interest highlights for

NYSE

stocks....

Memo: Have a dumb question relating to finance? Great. Have a problem with something I've written? Let me know at

MonEmailbag@thestreet.com, and I'll do my best to answer every Saturday. Include your full name, and please, no questions seeking personal financial advice or regarding personal brokerage disputes. And this reminder: Because of the volume of mail, personal replies can't be guaranteed.