Accounting for One-Time Gains and Matching the DOT
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.
