Recovery stocks: Neil Hennessy's best bets

FORTUNE -- For the past couple of years, we've kept up with the fund manager Neil Hennessy. The returns of his Hennessy Focus 30 (HFTFX) fund have been pretty impressive -- beating the S&P 500 by an average of 5 percentage points annually since 2003 -- and Hennessy's great for a blunt opinion on the market. But more than anything, he's fun to follow because his $145-million mutual fund is so unusual.

He calls it a quantitative fund, but it's about as far as you get from Wall Street's lightning-fast trading models. Hennessy runs a five-part stock screen of some 10,000 U.S. companies to pick 30 names to hold for a year. They have to be worth between $1 billion to $10 billion in market capitalization, trade for less than 1.5 sales (a truer valuation metric, he argues, than earnings), and post higher earnings than the year before. After that, he picks the stocks which have rallied the most (he'll ride short-term momentum) and gives 30 companies equal weight in the fund: 3.33%. Hennessy overhauls the portfolio once a year, usually in the autumn.

"We can't go to the companies," he likes to say. "The companies come to us."

The process eliminates some of the biggest roadblocks to good returns: believing you can time the market, and letting emotion take over.

Before we get into Hennessy's new stocks for the year, remember that he has to buy whatever passes his screen -- and it's not always intuitive. Take last year: he plowed into consumer discretionary stocks when recession-talk was rampant. Holdings like Ross Stores (ROST, Fortune 500) turned into big winners, as did lesser-known companies like Ball Corp (BLL, Fortune 500), whose metal cans for vegetables and packaged-food sold well as U.S. consumers scaled back.

So what does the fund look like now? First, it has doubled-down on consumer discretionary plays, boosting the stocks to nearly 50% of the portfolio from roughly a third last year. Williams-Sonoma (WSM), Family Dollar Stores (FDO, Fortune 500), and Jo-Ann Stores (JAS) all pass the screen. Crocs (CROX), which makes lightweight sandals, and Ulta Salon, Cosmetics and Fragrance (ULTA) round out the discretionary stocks. "The consumer has already shifted how they're buying," Hennessy says. "The question is, where do you want to be?" He thinks the fund is tracking the changes in U.S. consumer spending, which still accounts for more than two-thirds of GDP.

Also notable in the recent reshuffling: all consumer staple companies were dropped, and energy holdings were cut by 70%. "If you're coming out of the recession like I think we are, you want to be on the offense," Hennessy says. That's led the fund to interesting plays like automotive parts companies. BorgWarner (BWA), the turbocharger-maker, and Tenneco (TEN, Fortune 500), an emissions control manufacturer, are both new. "As you see auto sales increase, you'll see part makers increase," he says. "It's just logical."

In addition to overseeing several mutual funds, Hennessy is chairman of publicly-traded Hennessy Advisors (HNNA). A responsibility to his company's shareholders may help explain the hefty 1.4% expense ratio on the Focus 30 fund. It's a steep price to pay for a semi-passive fund. Hennessy himself acknowledges its simplicity -- "It's not rocket-science" -- and happily distinguishes it from actively managed funds.

So do some hard research before buying. Or just keep an eye on this one -- if nothing else, it serves as a reminder that patience and discipline can pay off.