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[Abstract]For 23 years, Brendan Wood International (BWI), a capital markets research and consulting firm started in 1970 that operates in 40 countries, has published an annual ranking of Canadian analysts in its report, Institutional Equity Research, Sales and Trading Performance in Canada. It is used by mutual fund and pension managers as a guide to more than 600 analysts who cover Canadian equities. BWI's research reveals a level of distrust of analysts by institutional investors. Investors should use their knowledge of pricing, inventories, and customer demand to come to their own conclusions.

In the heady days of the bull market, investors didn't really care whether analysts had a clue what they were talking about. After all, most equity researchers and economists were pointing investors in the same direction - up, up and away. In today's confused climate, however, it's a different story altogether. Whom should you listen to - the optimist with the generous earnings-per-share estimate on your favorite company, or the naysayer predicting bloated inventories and dwindling sales? Wouldn't it be great if someone researched the researchers?

Thankfully, someone already does. For 23 years, Brendan Wood International (BWI), a capital markets research and consulting firm started in 1970 that operates in 40 countries, has published an annual ranking of Canadian analysts in its report, Institutional Equity Research, Sales and Trading Performance in Canada. The data from BWI are coveted by Bay Street insiders, and highly confidential - parts of the 367-page tome are printed on red paper to make it harder to photocopy. It's used by mutual fund and pension managers as a guide to more than 600 analysts who cover Canadian equities. Now, retail investors like you can get a closer look at the people behind those research reports.

Canadian Business teamed up with BWI to present the All-Star Analysts in its report, gleaned from more than 9,000 analyst evaluations completed by a panel of 350 investment professionals. Essentially, the report reflects the quality of analyst research and knowledge, an analyst's exposure to institutional investors and the commissions each analyst receives by sector. Analysts are then awarded points and ranked in order. (For a more detailed methodology and a full chart of the top three analysts by sector, see page 42.) In this issue of the magazine, we profile seven All-Star Analysts who were ranked tops in their sectors, and one who is seen as a Rising Star in the banking sector. For more information, you can also visit our Web site (www.canadianbusiness.com) for profiles on the rest of the No. 1-ranked analysts, a total of 30 in all. There's a lot of research out there - so much that institutional investors told BWI they throw nearly half of it in the trash because it's irrelevant to them - and it can quickly become overwhelming. We hope this ranking simplifies matters and that it becomes a valuable tool for both do-it-yourself investors and those who take an active role in managing their portfolios with their brokers.

But there's more to getting the most out of analyst research than just studying recommendations, as institutional investors have learned. Throughout the bull market of the late 1990s, fund managers watched in dismay as the Chinese wall that once divided a firm's analysts from its investment bankers came crashing down. The result was concern that analysts' reports had become procompany propaganda, aimed at winning investment banking business for their firms. There's good reason for concern. In BWI's Investment Banking World Watch report released in fall 2001, it asked companies what criteria they use to decide which investment bank will lead equity offerings. The top two factors: analyst research and a commitment to ongoing research and trading coverage of their companies.

So it's little wonder that BWI's research reveals a level of distrust of analysts by institutional investors. Three years ago, those polled said that they trusted more than 45% of Bay Street's research. Today, that figure has dropped to just more than 30%, and investors predict their trust will continue to diminish in the coming years. "Three years ago, there was a move that said we should reduce our exposure to the kind of brokers that have large underwriting exposure, and support the more independent guys like Sprott, Octagon and Research Capital at the expense of the bigger guys," says Bob McWhirter, vice-president and portfolio manager with Triax Investment Management Inc. "Other institutions said, 'Nah, we'll just build our own in-house research department.' "

Among institutional investors, that seems to be the most popular approach to dealing with bias in analyst research--but it's not an option for the rest of us. Instead, McWhirter suggests we be more selective in our use of analyst reports. "You can use an analyst to give you five reasons for buying ATI or you can say, 'Give me what's going on with ATI as far as overall PC sales, and the average selling price of chips,' " he says. "Then you would come to your own conclusion as to whether you should be positive or negative on ATI."

Good analysts know the sector they cover inside and out. Many of them have worked in their respective industries for years before becoming analysts. As an investor, you should use their knowledge of things like pricing, inventories and customer demand to come to your own conclusions. As one institutional investor told BWI, "There is a difference between an analyst's 'opinion' and 'research.' I trust research more because it is based on facts." Sure, it takes more work than blindly following buy or sell recommendations. But hey, it's your money.

Another crucial tip we culled from fund managers is to get a feel for the tone of a report. The more neutral the tone, the more likely the analyst actually feels negative about the company he's covering. It's very common for analysts to write positive comments in their reports, while telling a completely different story to fund managers with whom they have close relationships. "There are two types of research," says one investor. "Written research cannot be trusted. However, one-on-one conversations with the analyst where he or she can be honest and open off the record--this type of research is valuable." Of course, that leaves retail investors out in the cold, so rely on that old axiom: buyer beware.

It is nearly impossible to find direct evidence that an analyst is being overly generous with earnings estimates and buy recommendations in an attempt to win investment banking business. What we can see, thanks to another study by BWI, is the wide gap that sometimes exists between those analysts who find favor with institutional investors and those who are prized by the companies they cover.

In its Investment Banking World Watch report, BWI asked 551 companies, "Which analyst best understands your company?" In some sectors, like banks, pulp & paper and telecommunications, investors and companies chose the same analyst for the No. 1 spot. But most times, that's not the case. In fact, companies chose CIBC World Markets as the top research team, while institutional investors chose BMO Nesbitt Burns, relegating CIBC to No. 5 on their top team list. In other sectors like health care, Yorkton Securities analysts Ezra Lwowski and Laurence Rulleau received high praise (tying for third) from the companies they cover, while investors ranked them both considerably lower. Or consider high tech, where companies voted CIBC's Barry Richards the No. 1 analyst. Institutional investors, on the other hand, sank Richards to near the middle of the ranking in high-tech software. There are many such examples, and though it's not a scientific comparison by any means, it shows that investors and companies often have different expectations from analysts.

It took only a few years to smash apart the long-standing wall between analysts and investment bankers (which, to be honest, had been showing cracks much earlier), and rebuilding it will be a slow and painful process. Purdy Crawford, the chair of the Securities Industry Committee on Analyst Standards, established by the Toronto Stock Exchange, Canadian Venture Exchange and the Investment Dealers Association of Canada, has laid the first bricks. The committee's final report was issued in November, and though Crawford is modest about its role in instituting change, the 33 recommendations the report contained clearly laid out what regulators expect from analysts and brokerage firms from now on. Many of the recommendations focused on better disclosure of conflicts of interest. "We're always going to have conflicts; it's just how they're managed," says Crawford. "I think I see better disclosure of conflicts, and I see more concern about being independent." More importantly--and this didn't get the attention it deserved when the report came out--the committee has made it clear whose head will be on the block if abuses continue. "The real responsibility for this is with the CEOs of the [investment] firms," Crawford says. "The analysts were just the jam in the sandwich. The CEOs are the people who should be looked to. They're the boss."

William Downe, the CEO of BMO Nesbitt Burns, must be doing something right. Once again BWI has ranked BMO Nesbitt Burns the No. 1 research team in Canada, for the 21st year running (first as Burns Fry, before BMO-owned Nesbitt Thomson bought the firm in 1994, forming Nesbitt Burns). The sheer size of BMO's research department gives it clout on Bay Street that few other firms can match. "They'll double-cover sectors so that each analyst can be more thorough in researching companies," says Trevor Torzsas, a partner at BWI. "They went with that strategy early on, and it's paid off."

Of course, with the slumping markets and dwindling resources, BMO may have trouble maintaining the same level of coverage. Not to mention the threat posed by US firms. Even though Merrill Lynch Canada has sold its retail brokerage to CIBC, its research department is intact. Merrill Lynch surpassed RBC World Markets (formerly Dominion Securities) to take the No. 2 spot this year so, as long as it doesn't completely pull out of Canada, it stands a good chance of closing the gap with BMO. "As pension fund regulations change to allow more foreign content, multinational broker/dealers will have an advantage," says Torzsas. Canadian firms aren't taking it lying down, though. CIBC World Markets has continued to push into the US market since buying New York-based investment bank Oppenheimer & Co. Inc. in 1997. Meanwhile the research departments at some Canadian banks are extending their coverage of US equities. Merrill Lynch is the only foreign firm to break into the upper tier of BWI's ranking--RBC is now ranked third for its research department, with Scotia Capital, CIBC World Markets, National Bank Financial and TD Newcrest rounding out the top firms.

If the bear market lingers for a long time, those analysts who are both thorough in their research and honest in their recommendations will become more important to all investors, institutional and retail alike. So take this ranking for what it's worth--as a tool to give you an edge when navigating the sea of analyst reports and recommendations. Happy sailing.