(FORTUNE Magazine) – Finding companies with managers who are friendly to shareholders is an important part of Mason Hawkins's search for the perfect stock. ''Before we buy we want to know that our goals and management's are common,'' he says. With his five partners at Southeastern Asset Management in Memphis, Hawkins, 40, runs $1.2 billion of institutional money and the $80 million Southeastern Asset Value Trust mutual fund. The group must have found some like-minded executives to work with last year, as their equity portfolios rose 36%, according to CDA Investment Technologies of Rockville, Maryland. That was more than twice the return on Standard & Poor's 500-stock index, counting reinvested dividends. Since Southeastern was founded in 1975, Hawkins and his team have outperformed the market every year but one and have never had a down year. In a recent interview with Fortune's Andrew Serwer, Hawkins talked about where he is prospecting in 1989.

You love companies with strong cash flow. Are you a recent convert? We have been looking at free cash flow for years. A company's ability to generate more cash than it uses is one of the most important criteria for selecting a business to own. Our method of calculating free cash flow is to add net income to depreciation, depletion, and amortization, and subtract capital expenditures.

Why is management so important to you? Managers are like someone with a portfolio of high-coupon bonds: To maintain the yield they must be able to invest interest income at the same high rates. We want managers who will be able to reinvest excess cash at a high rate of return. When they do, it means they have the shareholder on their minds.

When does a stock look inviting? We have several ways of gauging value. We look at the assets, and we take the present value of the free cash flow stream. We come up with a per-share number for a company, and we will buy a stock only if it sells for half of what we figure the company is worth.

Is Memphis-based Federal Express a hometown favorite? We owned it before, sold it, and now we own it again. Federal Express is one of our largest holdings because we think it is in a duopoly with United Parcel Service. Costs are declining while prices for the first time are flattening and could even go up. Margins are increasing, and volume growth is strong. Federal's acquisition of Tiger International should be approved soon by government antitrusters, but even if it isn't, we think the company could earn over $6 a share within two years. The stock is in the low 50s today.

Where else have you made a big bet? Another stock we have a significant stake in is Coca-Cola Enterprises, the giant bottler. This company, whose stock goes for $16 a share, is amortizing a tremendous amount of goodwill after some acquisitions. Pretax cash flow should be over $500 million this year, which we think makes the company worth close to $30 a share. We bought it at $13. The company recently announced it was selling its Kansas City-based bottling operation and using the proceeds to buy back 18% of the shares.

What about technology stocks? We don't understand technology so we don't own any. Centel, the telephone company, is about as close as we get. CEO Jack Frazee is a dynamic manager who has probably done more in his short tenure than anyone I've ever seen at a major company. He made a major cellular acquisition for a reasonable price. He's instituted a five million share stock repurchase program. And he is selling Centel's business systems division and a cable company. The stock sells for around $57 a share, and we appraise the company at $90.

Why has Knight-Ridder stock caught your eye? It has a new CEO, Jim Batten, who we think is doing about as much as one can do in a short time to create value for shareholders. He bought Dialog, a database distributor. He's selling eight television stations in a hot market and unloading some newspapers. Batten is also aggressively shrinking capitalization because he can, in a sense, buy newspapers cheaper by repurchasing his stock than by trying to buy companies. Knight-Ridder stock is , around $45 a share, and we think it's worth $80 or more.

You own Ogilvy Group. Does its new poison pill bother you? No sir, because we think that the present management can get value out of the company for us. We think Ogilvy Group can earn over $3 a share within the next couple of years, and the stock trades around $30.

Insurance stocks don't frighten you? It is an industry headed south, but we like Fireman's Fund and Coroon & Black, an insurance broker. Management at Fireman's Fund is shrinking equity from 63 million shares in 1987 down to 40 million in 1989. It has sold preferred stock convertible at $42 to $48 and is using the proceeds to buy in common at the recent price of about $30. The company should earn $3 or $4 a share this year, depending on the performance of its investment portfolio. Coroon has $180 million on its balance sheet, which it might use to buy in shares, pay an extra dividend, or make an acquisition.