CHIP, CHIP, HURRAY!

Wednesday's rally sent the likes of Applied Materials and Intel up 5.2% and 5.5%, respectively, as the Philadelphia Semiconductor Index rocketed 8.3%. Telecom and telecom equipment joined the party, too, since everybody loves a potential turnaround story.

To troll for other potential turnarounds, we used our stock-screening tool to find undervalued shares based on a gauge called the price/sales ratio. This expresses how much investors theoretically pay for a slice of a company's annual revenues. P/S ratios are higher in some sectors than in others, but, generally speaking, companies trading for less than 0.5 times their annual sales are held in low regard by investors. Often, they're struggling to remain profitable or even solvent. When one such company manages to keep its sales steady while dramatically cutting its costs, its profitability increases, and a turnaround story is born. Investors focusing on the company's steady sales and low price/sales ratio might have seen this coming.

We aren't the only ones who favor the price/sales ratio. A recent study by Merrill Lynch technology strategist Steve Milunovich gives the P/S high marks. Milunovich measured the effectiveness of several popular technology-stock-picking tools from 1986 to 2000. During that volatile 14-year period, he found, price/sales ratios proved to be more predictive than such well-known ratios as price/earnings (both trailing and forward), price/book, price/cash flow and price/earnings/growth. And James O'Shaughnessy, in his 1996 best-selling book "What Works on Wall Street," called the price/sales ratio "the king of all value factors." He writes: "The market clearly and consistently rewards...stocks with low price/sales ratios...over long periods of time." To come to this conclusion, the money manager studied more than four decades' worth of market data from the 1930s to the mid-1990s.

We featured this screen last month The second looks for the lowest-priced stocks relative to sales without regard for recent price momentum. To hunt for potential turnaround stories this week, we chose the latter approach. (If you open our stock-screening tool for yourself, you'll find it saved under "price/sales 2" among the menu of more than 20 SmartMoney screens. You can run these at any time, using the very latest data available.)

You'll find our low price/sales recipe is refreshingly simple. We hunted for stocks trading for less than a third of the Standard & Poor's 500's average price/sales ratio (1.2). This group of 1,646 stocks should be considered cheap by any yardstick. But we still had some filtering to do. We dumped higher-risk issues by weeding out heavy debtors and microcaps. Finally, we shunned businesses in long-term slumps by demanded positive five-year sales growth. This four-step process whittled our long list of 8,300 stocks down to just 54. (Click here

You don't see a lot of tech stocks on this list. Many of them still trade for hefty premiums to their sagging sales, like Intel at 4.5 times sales and Yahoo! at 11.6 times sales. That's far too rich for our blood.

But a number of so-called consumer-discretionary stocks made our cut. These apparel stores, electronics retailers and the like have been hit hard by fears of a weak Christmas. Yet Ed Hyman of ISI Group (and one of SmartMoney Magazine's "30 Smartest People in Investing" this year) thinks these fears are overblown, and recommends his institutional clients to be overweight consumer-discretionary stocks in their portfolios. "We believe that [a] surge in [mortgage] refinancing, rising real purchasing power, still-strong home sales and lower interest rates could all work to make this Christmas season a little more jolly than the [average analyst] might expect." Even after Wednesday's lower housing starts figures came out, Hyman continues to see the housing market as strong, with core home prices continuing to rise.

So what looks most interesting in the consumer-discretionary pile? Saks first caught our eye. The department-store chain has been a fixture in the news since Winona Ryder was arrested for shoplifting there and ultimately found guilty. But late Tuesday, Saks reported a surprise profit, thanks to tighter cost controls. Earnings amounted to three cents a share, compared with a loss of three cents last year. Be warned, though: Revenues slipped slightly, from $1.42 billion last year to $1.41 billion. Those lower sales and Saks's one-day stock-price jump of 13% pushed the precious price/sales ratio up, though it still comes to a low 0.3.

Discount clothier Burlington Coat Factory doesn't offer $200 hair bows a la Saks, but its price-conscious clothing may be just what the economy ordered this shopping season. Burlington reported a loss last quarter, as it traditionally does in the fiscal first quarter (ended Aug. 31). But analysts are expecting the chain to swing back into the black as the weather cools. With a price/sales ratio of 0.3, getting in before the next profitable quarterly report (expected in December) might keep you warm for the winter.

Over in the book aisle, note that Barnes & Noble made our list while rival Borders Group didn't. That's because Borders' share price has climbed enough since hitting a 52-week low in July to make it too expensive for our cheap-stock search. If you look at the two stocks with our stock-compare tool, you'll see Barnes & Noble sports a slightly larger market cap than Borders, but its sales are notably larger than its rival's. That makes for a better-priced stock in our book.