(MONEY Magazine) – If you're wondering whether the bull market is back, look no further than Wall Street's bottom line. According to the Securities Industry Association, 2003 will likely be the most profitable year ever for securities firms, with total earnings topping $22.5 billion, up from just under $7 billion last year. Not surprisingly, investment bank and brokerage stocks were also among the hottest on the market in 2003, posting an average gain of 55% for the past 12 months vs. a 21% rise in the S&P 500.

Brokerage stocks are typically the first winners in a bull market--after all, they collect all the fees and commissions when investors start buying again. Now investors in these firms face two big questions: Will the market rally continue? And is the boom fully reflected in brokers' share prices?

The first question may be an imponderable. As to the second, it's fair to say that financials are still on the cheap side, if no longer extraordinary buys. The key number to look at with these firms is their price-to-book-value ratio, or their share price relative to the value of their assets minus liabilities. (Since brokers' earnings are volatile, their price/earnings ratios usually stay low.) Citigroup, Goldman Sachs, Merrill Lynch and Morgan Stanley are all trading at discounts to their five-year average P/B ratios. "The fundamentals are getting better, and compared with where they've historically traded, the valuations are very reasonable," says Mike Holton, portfolio manager of the $350 million T. Rowe Price Financial Services Fund, which owns Merrill and Morgan Stanley.

There are some risks, though. For a start, one reason Wall Street firms are so profitable right now is that they've just come off a period of painful cost cutting. Since the bear market began three years ago, nearly 50,000 of 840,000 securities jobs were cut, and compensation was slashed. That belt-tightening means more of each new dollar of revenue flows to the bottom line. Just don't expect the new lean-and-mean ethic to stick. "Brokerage firms repent during bad times and spend like drunken sailors in good times," says analyst Brad Hintz of Sanford Bernstein. Already, the industry has added 8,800 jobs, and merit bonuses will be up 15% to 20% from 2002.

Another big driver for Wall Street's record profits has been trading for the firms' own accounts in fixed-income securities, commodities and other financial instruments, says Ray Soifer, an industry watcher and chairman of Soifer Consulting. But trading profits are unpredictable, and analysts think fixed-income trading is unlikely to be as lucrative as it was in 2003. Unfortunately, firms don't break out trading results in their earnings reports.

Which brings us back to the basics. Investors should put less weight on the windfalls of the past year and focus on firms that have the most to gain from merger-and-acquisition and underwriting activity, both of which are just starting to pick up again. T. Rowe Price's Holton likes Lehman Brothers (LEH), which he also owns. Though Lehman has typically earned most of its revenue from fixed-income underwriting and trading, it took advantage of the bear market to buy into new businesses, including fund manager Neuberger Berman. Lehman now earns 25% to 40% of revenue from equities, says Holton. And at 1.9 times book, it should still have room to rise. --DONNA ROSATO