The earnings figures released over the last month are absolutely hideous, scary really, yet Wall Street hails them as a sign of recovery and safety.

Revenues are at a fraction of where they were this time last year, yet they beat analyst expectations.

Earnings, if a company is lucky enough to find a profitable strategy, are down by figures like 80%, 90%, even 95%, yet shares are moving up. Investors figure even a couple of bucks in free cash flow is better than nothing.

But what so many investors and even analysts are overlooking is where the surprising figures are coming from. According to reports like today’s dismal same-store sales figures, the extra cash is not from spend-happy consumers.

Instead, companies are slashing headcounts, cutting services and doing absolutely anything they can to increase their margins. In other words, they are burning their house down to cut their electricity bill.

It is great in the short term, but what about the long-term effects?

Not going to be pretty

A perfect example of the recent phenomenon comes today from HSN, Inc. (NASDAQ:HSNI), a.k.a. the Home Shopping Network.

Shares of the couch-potato-friendly shopping channel are up by about 20% today on the news the company was able to cut costs and increase margins enough to squeak out a profit of $11 million even though revenues dropped by 8% during the quarter.

For some perspective, this time last year the company reported a loss of $249.8 million.

The comparison begs the question why didn’t the company cut costs last year when it was hemmoraghing cash?

Easy answer… it did not make strategic sense. It would have been detrimental to the company’s core business if it made a drastic cut to expenses.

So why did the company do it this time? It had no other choice. With credit tight and few signs of any worthwhile recovery, it was cut or be cut for HSN.

But that does not mean the reductions in spending are any better for the company now than they were this time last year. Chances are, we will see the detrimental effects well into the future, in the form of lost market share and slow growth.

For HSN and the plethora of other companies making the same margin-boosting reductions, the key variable will be if their cuts were less detrimental than their competitors’ cuts.

No time to think… just hope and  pray

When marketing, employee benefits and customer service expenses are reduced, there is no doubt it will have a negative impact on a company’s future growth. All there is do is hope its competitors cut just as much or more.

This is an ultra-important consideration for today’s investors. While the bulls may be rushing forward with no ultimate destination in mind, eventually the turnaround stories are going to come to an end and the markets will beg for organic growth.

The only companies adding to their shareholder wallets will be the firms actually able to increase top-line growth. These days, there are not too many of them out there.

Education companies like Apollo (NYSE:APOL) and Grand Canyon Education (NASDAQ:LOPE), which earlier this week announced a 72% top-line increase, are good candidates going forward.

So are companies like, I can’t believe I am going to write this, Sirius XM Radio (NASDAQ:SIRI).

If you can handle the throng of annoying, Howard Stern-obsessed shareholders and the risk associated with the penny stock, today’s report that the company managed to meet expectations and increase its top-line by 1% is some of the best news the company announced in a long time.

Basically it is like this: You can burn down your house to lower your monthly utility bills, but when it is time to crawl into bed, you may regret the move.

Just because a company manages to cut its costs further than expected does not mean its share price should rise. The bewildered market is making a lot of mistakes these days.

Source: Burning the House to Save Money

But there are profits to be made in the small-cap market says Laura Cadden in Today’s Financial News. She’s found three great small-cap stocks going for bargain prices. All three have solid valuation ratios and strong short-term growth prospects.

They are Javo Beverage Company (OTC:JAVO), The Home Shopping Network (NASDAQ:HSNI), and Take-Two Interactive Software (NASDAQ:TTWO).

Best Small Cap #1

A poor man’s Starbucks: Javo Beverage Company, Inc. (OTC:JAVO).

Ah… coffee. Coffee addicts NEED their java. But we’ve already seen that in tough times, people are stepping away from the Starbuck’s counter.

That’s where these guys come in.

Good, fast and CHEAP coffee

Javo Beverage Company, Inc.’s main focus is on dispensable tea and coffee. The company manufactures and markets beverage concentrates, as well as formulations, extracts and flavors, to restaurants and retail outlets.

A sampling of their client list includes 7-Eleven, Sysco Food, BP Products North America, Exxon-Mobil, Mrs. Fields, Haagen-Dazs, Caribou Coffee, Sunoco, Shamrock Foods and Speedway.

Javo greatly increased their outlet potential in the second quarter of this year resulting in excellent results primarily from iced coffee sales.

On July 30, the company announced record revenues for the second quarter of 2008 of 6.7 million. A record gross margin of a remarkable 49% was also achieved for the quarter.

Javo’s target for dispenser installation for this year was 7,500. They achieved that goal by the end of July.

Turning to their hot coffee product, they are now ready to have 10,000 dispensers in place by year’s end. Each new location is anticipated to produce between $3,000 and $6,000 in revenue annually.

This company is one of the most promising small caps I’ve seen this year and the price is below $1!

What’s not to love?

I recommend you buy shares of Javo Beverage Company, Inc. (OTC:JAVO) for at or under $0.60 a share.

*****

Best Small Cap #2

On the cutting edge of retail: The Home Shopping Network (NASDAQ:HSNI)

Her name is Mary-Ann and she is an addict.

Her addiction? The Home Shopping Network (HSNi) owned and operated by HSN, Inc.

Mary-Ann (actually NOT her real name) tells me that she can’t help it… the convincing chatter by charming hosts, the phoned-in testimonials, the seemingly reasonable prices, the “limited number available” push, and the countdown clock – it just wins her over every time.

She’s not alone… The 24/7 HSNi channel reaches 90 million households in the U.S.

And in 15 million of those homes, they also have the latest technological advance in TV purchasing – Shop By Remote.

In addition, HSNi has one of the top 10 e-commerce websites (http://www.hsni.com).

Cornering the market

HSN Inc. has another operating segment, Cornerstone, which is made up of seven popular brands including The Territory Ahead, Smith+Noble, Frontgate, Ballard Design, Garnet Hill, Improvements and Travelsmith.

Each brand has its own website and catalog (400 million are mailed out annually!).

HSN, Inc. began trading on its own in late August.

Formerly, it had been part of IAC/InterActiveCorp (NASDAQ:IACI) but was spun off along with Interval Leisure Group, Inc. (NASDAQ:IILG), Ticketmaster (NASDAQ:TKTM), and Tree.com Inc. (NASDAQ:TREE).

Since the separation (and the volatile market in recent weeks) the stock price has decreased in value.

Its current PE ratio is hovering around 6 – always a good thing!

Most importantly, these people KNOW how to sell and with the peak retail season fast approaching, I expect this stock price to climb steeply.

I recommend you buy shares of HSN Inc. (NASDAQ:HSNI) at or under $12.

*****

Best Small Cap #3

Failure to merge = good news for you: Take-Two Interactive Software, Inc. (NASDAQ:TTWO)

After prolonged negotiations, Electronic Arts Inc. (NASDAQ:ERTS) will not be purchasing Take-Two Interactive Software, Inc.

News of this prompted seven-year lows in the stock price of Take-Two providing a great buying opportunity.

Highway robbery

Take-Two’s claim to fame (or infamy, depending on your perspective) is its “Grand Theft Auto” video game series.

Wildly successful, these games often top the list of objectionable entertainment due to their seeming glorification of criminality and excessive violence. (No doubt that accounts for much of their popularity.)

A sampling of Take-two’s other franchises include Sid Meier’s Civilization, Manhunt, BioShock, Sid Meiers’s Railroalds!, Top Spin, Sid Meier’s Pirates, and Max Payne.

Headquartered in New York City, the company’s publishing segment is made up of Rockstar Games, 2K Games, 2K Sports and 2K Play labels.

Can’t argue with the numbers

After a showing a negative balance in 2007 (with a net margin of –14.10%), Take-Two clearly buckled down their operating expenses. That, and the over 6 million(!) copies of Grand Theft Auto IV sold after its April release, resulted in an increased net margin of 11.95% as of Q3 (ending July 2008).

The company’s PE ratio is just under 12, its forward PD is 10.81 and its PEG is an amazing .56. Now with recent market devaluations, these numbers are not the full picture, but they are still indications of a good investment.

On the table

The Take-two executive chairman of the board, Strauss Zelnick, has said that the company is communicating with other parties to consider “strategic alternatives.”

Any additional takeover bids should be good for shareholders.

Besides the decent fundamentals, profits and buyout possibilities, there are all those fans that failed to get “GTA IV” in the spring. They will no doubt be placing it at the top of their hoped-for holiday gift lists, which should give the stock price a nice bump.

I recommend you buy shares of Take-Two Interactive Software, Inc. (NASDAQ:TTWO) at or under $21.

Source: The 3 Best Small Caps to Own This Fall: A TFN Special Report