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A friend of mine recently asked me what’s the best way to invest in a hedge fund. I said to buy shares of Goldman Sachs (GS). Not only does it get a piece of most hedge funds, but it’ll probably make more money than most of them. The company has already broken its yearly profit record, and there’s still another quarter left to go.

Since April, investors have been selling off shares of brokerage stocks due to concerns about a slowdown in the investment banking business. Some of the stocks now have single-digit P/E ratios. It’s true, there has been a slowdown, but it’s far less than initially feared.

This morning, Bear Stearns (BSC) became the latest Wall Street firm to beat expectations. And unlike Goldman Sachs and Lehman Brothers (LEH), Bear Stearns reported a profit increase instead of a better-than-expected decline.

For the third quarter, Bear earned $3.02 a share which was 15 cents more than Wall Street’s consensus. The company’s largest business segment, fixed income, jumped 18.8% from last year’s third quarter which more than made up for the 22.6% slide in investment banking revenue. The most impressive growth came from the firm’s equities trading business which rose by 30.6%. Clearly, trading is where the action is.

Since many investment banks begin their fiscal year on December 1, we’re getting third-quarter earnings reports now. Yesterday, Lehman Brothers reported earnings of $1.57 a share, which topped Wall Street’s forecast by eight cents a share. On Tuesday, Goldman jump-started the rally for the sector by announcing earnings $3.26 a share compared with analysts’ forecast of $2.97 a share. Interestingly, Lloyd Blankfein, the new CEO, has a background in trading, not investment banking.

Next week, Morgan Stanley (MS) will be the next bank to report its earnings. The current consensus estimate is for $1.37 a share.

Here's how the five major brokerage stocks have done over the past four years:

Posted by edelfenbein at September 14, 2006 10:18 AM