“Investors have long known they have to take Wall Street analysts’ stock research with a grain of salt,” writes Raymond Hennessey in today’s Wall Street Journal.

“But they might consider swallowing a whole ocean when it comes to a recommendation about a company for which the analyst’s firm did the IPO-underwriting work.”

“According to data over a four-year period from Investars.com, an online investment information service, investors lost an average of 53.34% when they followed the advice of an analyst employed by a Wall Street firm that had led or co-managed a particular stock’s initial public offering of stock. By contrast, investors lost just 4.24% when they took the suggestions of analysts whose firms had no underwriting relationship with the companies researched.”

“Both results are poor. What is striking is the disparity between the performance of stocks promoted by analysts whose firms have something to gain — namely, lucrative underwriting fees — and other, nonaffiliated stocks. In many ways, the Investars data further quantify what many investors have believed for some time: The so-called Chinese Wall that is supposed to separate a firm’s analysis and investment-banking business has cracks.”

” ‘We have analysts come through here all the time, and we know to be careful,’ said David Klaskin, a money manager and president of Oak Ridge Investments in Chicago. ‘The overall quality of research isn’t good.’ “

“Still, savvy investors often know that there is a subtext to many analysts’ ratings, particularly when the firm is trying to protect an investment-banking relationship, Mr. Klaskin said.”

“Also, some investors can bypass analysts’ coverage altogether: Larger institutions have their own industry analysts, while midsize and small firms often pick a handful of analysts they trust and use them, ignoring others. But for the average individual investor, buying such advice usually isn’t an option. ‘It’s caveat emptor,’ says longtime market observer and Harvard University Professor Samuel Hayes.”