FINISHED CHRISTMAS SHOPPING?

Traditionally, the year's first month has been good to Wall Street, with stock prices rising most years in what has become known as the "January effect." If the tradition continues, investors who buy in early will reap rewards. That's why we've run a January-inspired screen this week.

But before we get to the recipe, let's take a look at history. The market has gained value in more than two-thirds of the Januaries since 1926. Even more promising: According to Merrill Lynch research, the likelihood of a January bounce climbs from 70% to 90% after a down year for the market like this year will surely turn out to be. Why? There's a tax incentive to dumping losers before the end of the year. Big tax-loss selling lowers valuations and puts extra cash in investors' pockets two critical ingredients for January buying.

The January effect is most pronounced among small-cap stocks. According to Merrill Lynch research, small-cap stocks have climbed an average of 2.6% in the Januaries dating back to 1926, while large caps have climbed a more subdued 1.1%. Merrill Lynch's chief small-cap strategist, Satya Pradhuman, believes this is at least partly a result of information flow. There's generally less information available regarding small stocks, and much of the news tends to be released at the end of the year. Thus, investors may be best informed and ready to buy small caps in January.

To find the stocks that may benefit most from the January effect, we started by homing in on the market's small fries. Using our stock-screening tool, we zeroed in on issues worth between $200 million (which is our microcap cutoff) and $1.5 billion (where midcaps begin).

Of course, we didn't want just any old small-cap stock. We concentrated on value, not growth, because small-cap value funds have significantly outperformed small-cap growth funds during January for the past 18 years, as Merrill Lynch's Pradhuman wrote Monday. The former returned 2.8%, on average, over the course of the month, while the latter returned 2.0%.

In search of value, we focused on stocks trading at or near their 52-week lows. In December, the list of lows is a good place to start bargain shopping, because these bottom feeders are more likely to get dumped by fund managers who are prettying up their portfolios before disclosing holdings to investors. (This is known as window dressing in Wall Street parlance.)

But that was just the first step. In order to distinguish unjustly oversold issues from those that deserve to be punished, we focused on share price relative to a company's underlying profitability. Specifically, we demanded that stocks trade for less than the S&P 500 average P/E of 16.8 (based on current-year estimates gathered by Thomson First Call) and less than its own industry median P/E. We also made sure Wall Street is expecting earnings to climb in the year ahead. The hope is that the stock will climb in the year ahead, too.

As usual, we added a couple of quality filters to improve our screen results. First, we didn't want heavy debtors, so we eliminated companies whose debt totals 50% or more of their total capitalization. Second, we insisted on heavy insider ownership. Companies with a lot of insider ownership have historically fared better in trading than companies where employees have less of a vested interest, according to a study conducted by Washington, D.C., consultants Watson Wyatt.

After all of these requirements, we were left with 15 small-cap stocks with value characteristics from casino owner Argosy Gaming to home builder Walter Industries. (You can view the list by clicking here Our survivors have taken a beating this year, but none more than Interstate Bakeries. Shares of the bakery chain fell 35% on Tuesday to an 18-month low after it reported disappointing earnings. IBC reported operating earnings of 33 cents for the quarter ended Nov. 16 a full 15 cents below expectations. The company's sales slipped slightly, but it really felt the earnings pinch from higher cocoa and sugar costs.

Yet after this sell-off, Interstate Bakeries' stock looks as cheap as day-old muffins. Shares fetch just 7.7 times current-year earnings far less than the industry's average of 16.6. Right now, fund managers may be thinking more about the hate mail they'd receive if Interstate Bakeries appeared in their annual reports and less about the current value. That smells like an opportunity for investors willing to take a risk on a company that could disappoint again.

Our screen also turned up burger joint Jack in the Box and restaurant chain Steak N Shake. Jack in the Box might well worry after larger rival McDonald's said Tuesday that it expects to post its first-ever quarterly loss, thanks to weak sales. But note that Jack in the Box is currently trading a full 40% below its average P/E for the past five years. And Jack in the Box has seen some tough times in the past (think: E. coli), yet has bounced back. Meanwhile, Steak N Shake is trading 28% below its historical average. Even so, last week, the company restated its past earnings to reflect a change in the way it accounts for its leases. We'd avoid this stock until it's clear that the P/E has a reliable E to stand on.

If all this talk of troubled restaurants leaves you nauseous, look to our more popular survivors. Lottery-equipment maker Scientific Games and medical-supply company Vital Signs are the most highly recommended by analysts of all of our small-cap value survivors. These two companies are expected to increase their earnings by more than 14% next year. And both already look cheap based on current-year expectations. Scientific Games' stock has a P/E of 14.0, while Vital Signs sports a P/E of 13.1. Based on historical precedence, January could be very good to stocks like these.