In an age when many Wall Street research departments are little more than tools of their firms' investment banking units, how can the investor best use their work to make money? You cannot simply dismiss their work because it can move stock prices. On the other hand, you would be unwise to rely on their buy recommendations.

To better understand how to exploit, or avoid, the avalanche of

sell-side research raining down on investors, I talked to a quartet of professional investors who get paid to beat the market. These are men and women whose livelihoods depend on getting market and stock picks right. So, it's instructive to learn how they use sell-side research.

The first thing they tell you about Wall Street stock research is that you should

never, ever

base an investment decision on an analyst's recommendation. (In the euphemistic lingo of Wall Street, a strong buy means buy the thing. A hold means sell. And a sell means you should have sold already. My colleague

Dagen McDowell

recently deciphered this

lexicon for readers.)

"We don't listen to any of their opinions," says one hedge fund manager based in midtown Manhattan who has outperformed the

S&P 500 in each of the past three years and so far this year too. "They have very useful facts and allow us to leverage all the legwork they do, but at the end of the day, it is our judgement and not theirs about the stocks we buy. They help fill in the mosaic for a particular investment idea. We then have to make the judgement about whether the analysis makes sense or not. Their analyses are worth noting, but you should discount their buy recommendations almost entirely."

Her partner chimes in that it's important to be on the alert for the amazing "herd mentality" of the analytical community, too, which can magnify the effects of the lead cow's move.

It was not always quite so bad, he notes. Once upon a time in the era of fixed brokerage commissions, Wall Street firms were rewarded for providing unique research. Customers paid full commissions in exchange for good stock ideas. And research departments were supported by those commissions, not entirely from the money that the investment bankers were hauling in. Now, brokerage commissions are far lower, which is great; but an unintended side effect has been the rise of the cattle call by analysts.

"In the old days," he adds, "there were more sell-side boutiques that got rewarded for helping the investor understand a company or a stock from a different point of view. That doesn't happen now. Now, you have many people saying the same thing at the same time. No one is rewarded for sticking his neck out on a call." Today, analysts rarely make 180-degree turns. Sometimes they never change their tunes at all. Combine gradualism with the common wisdom and you can get research that fails to alert you to trouble ahead.

Take, for example, the cattle call on

Exodus

(EXDS)

, an Internet services provider whose stock price peaked at 179 5/8 on March 24, and then collapsed to a low of 52 1/2 last week. (It closed Wednesday at 79 1/4.) The "consensus" Wall Street recommendation, according to

First Call/Thomson Financial

, was that Exodus was a buy in late March at 179, a buy in early April at 146, a buy in late April at 90, and, of course, a buy in late May at 52 1/2.

Exodus Tanked
But the Buys Stayed On

"I guarantee you that when Exodus started falling, the analysts reiterated their buys," says another investment manager who runs a small hedge fund.

This guy describes what he calls the typical research cycle for a stock like Exodus.

"Here is how it works," he says. "You have a stock that trades for months or years at, say, $20-$25 a share on low volume. Then it breaks out on, say 3 million shares, way higher volume and closes at 26. The 'generals,' by which I mean the

Fidelitys

and

Putnams

, are buying. The stock goes to 30 on this buying. Most people, including the big sell-side firms, still don't really care too much about the stock. But the Fido's of the world are consistently buying on any pullbacks. Then the company announces all of a sudden a pickup in earnings and revenue. All of a sudden, the analysts say the company has reported a good number and they raise their earnings estimates a bit and half the analysts upgrade their buy recommendations. The stock goes to 40. Then they get guidance from the company in the next quarter that business may be even better, and the analysts raise earnings estimates again. Then the other analysts raise their recommendations.

"Now comes the big kicker -- the momentum players, the momo guys, come in and take the stock from 65 to 90. Now the press starts writing about the company. It makes the cover of

Forbes

or

Fortune

or

Business Week

. Some analyst sets a new price target of 125. Meanwhile, the Fidos and Putnams begin selling into the rallies. The company beats estimates one more time, but the company warns that because it is building a new factory it may only meet the new higher estimates next quarter. That's the ballgame. Estimates are not going up anymore, so the momo guys sell. The analysts have not changed their recommendations, but the game is over. That is the cycle that gets played out every day in the market."

So what is an investor to do? Wise up.

If you are a trader, you want to keep up with the Wall Street estimates for the company because they can whipsaw a stock up or down. Find out who the "ax" on a stock is -- the analyst who can move a stock price because he or she is seen to have great access to company management. For instance,

Goldman Sachs

analyst Rick Sherlund is the ax on

Microsoft

(MSFT) - Get Report

. Read what he or she writes, even if you disagree with it.

How do you recognize an analyst who is little more than a shill for his firm's investment banking division, whose analysis is aimed at helping land more underwriting from the covered company?

It's pretty simple. If a company announces really bad news, and the stock goes down, and an analyst spins the news positively, be suspicious. "Numbers don't lie. People lie," says the small hedge fund manager. "How a stock price reacts to news, good or bad, is more important that what an analyst has to say about the news."

Beyond the analysts who covers specific stocks, there are the market strategists. Professional investors say that strategists like

Morgan Stanley Dean Witter's

Byron Wien and

Merrill Lynch's

Bob Farrell,

DLJ's

Tom Galvin or

Paine Webber's

Ed Kerschner can also be helpful, if only to provoke you into thinking about the market's mood music. These guys have been around a long time, have good access to top investors and, even if they are dead wrong, are usually interesting.

Forget their "recommended lists," which are designed for institutional investors who feel the need to be 100% in stocks all the time. As one hedge fund manager says, "Do you think

they

own their buy lists?"