New breed of analyst delivering a shock to the system

WHEN IBM shocked Wall Street recently with a shortfall in earnings, a few investors were not surprised - clients of a leading independent research firm had advance warning that Big Blue's numbers were not adding up.

The Center for Financial Research and Analysis is one of the boutique research firms that saw problems with IBM before the company alerted the public. Director Howard Schilit, author of the book Financial Shenanigans, says the 14 analysts in his firm have one mission - to crunch numbers of the biggest companies in the US and Europe to seek out those in trouble.

The 100 or so independent analysis set-ups do not take advisory fees from the companies they cover and were somewhat obscure until the dotcom bomb and the collapse of energy trading giant Enron made their prescient warnings headline news.

The interest of investors in independent analysis has shot up in the wake of allegations that Wall Street research cannot be counted on to uncover the sort of accounting tricks that took place at Enron. Some believe analysts were fooled by Enron's deception, others fault the pressure on them to be positive.

Whatever the cause, US government investigators continue to unearth poor investor advice tainted by possible conflicts of interest at major investment banks. While Merrill Lynch, Goldman Sachs, JP Morgan Chase and CSFB were busy touting Enron shares as buys or strong buys, a handful of independent research analysts raised red flags. Computrade Systems and Alpha Equity Research advised clients to sell when the shares were in the $50-to-$60 range, long before high-profile analysts changed their views.

The Enron debacle and ongoing probe into Wall Street analysts' overly optimistic ratings of internet stocks that later imploded have made hard-hitting independent research a hot commodity. 'Our business has expanded because it is our job to look for problems - we are trained to look for accounting quirks,' said Schilit, whose Maryland-based centre recently opened in London. 'Wall Street analysts get paid not to rock the boat.'

Earnings tracker First Call's director Chuck Hill said there is an inherent bias to put a positive spin on ratings in an industry that underwrites, trades, sells and promotes shares. Less than 2% of stocks are rated sell or strong sell, he said.

Independent expertise devoid of overt conflicts is not cheap. Schilit's mostly institutional clients pay about $3,000 (£2,150) a month to subscribe to the service.

Company-specific reports can be purchased a la carte for $300, 30 days after issue. Anyone who reads his 1999 and 2000 reports on one-time tech darling Microstrategy would not have been surprised when it floundered. Shortly after Schilit issued one damaging report, Merrill Lynch, Microstrategy's investment banker, put out a detailed rebuttal telling clients to ignore the rumours, he said.

The high cost of quality research has traditionally put it out of the reach of most retail investors. However, that is changing as demand grows. Several companies now offer individual company reports from $10 to $300 over the internet. Jaywalkin.com, a popular investor site recently purchased by Bank of New York, includes reports from 15 independent firms.

Most independents get their research from primary sources - publicly available data, such as quarterly filings and annual reports. They do not schmooze with executives, nor do they do on-site tours. Experts say the best firms have a proven track record of spotlighting firms before a fall, take no advisory fees from the ones they cover and do not buy and sell shares based on their own research.