(FORTUNE Magazine) – Sometimes Warren Isabelle, 42, can be a bit gloomy. "How am I doing today? Terrible," says he, as a greeting. In a business of rampant bullishness, Isabelle clearly isn't afraid of being negative. That extends to his stock- picking style. Companies with complex stories or down-and-out reputations are the fodder he feeds on. Isabelle favors small-cap companies, which he has stuffed into his $337 million Pioneer Capital Growth fund. The battered bunch has taken on quite a glow over the past five years, returning 19.6% on average annually to investors, vs. the 8.8% rate of return for Standard & Poor's 500- stock index. From his post in Boston, Isabelle spoke with FORTUNE's Susan Kuhn, cheering up as he talked about his stocks and their prospects.

Warren, what's with the market? We are experiencing a lot of unsettled weather. I can't imagine why the market went up in the face of an interest rate increase. The simple fact is, the higher the cost of capital, the lower the value of stocks. I am not terribly excited. It is going to be a stock-picker's market for the foreseeable future. It is true that many well-known cyclical stocks have discounted a lot of the benefits of economic recovery. But I am finding several smaller companies that haven't had the luxury of being discovered.

Describe your portfolio. I own companies in the midst of a turnaround or transition, or poised to / benefit from a cyclical turn. I am looking to hold a stock for one to three years. About 33% of the assets are in technology stocks. Basic industries and capital goods represent 17% and 16% of assets, respectively. Whittaker had over 100 businesses in the 1970s. It has since sold everything but its aerospace and defense electronics unit, which makes a lot of black-box stuff like radar-tracking systems and aircraft controls. What's exciting is that the technology keeps sprouting and building new businesses. Whittaker has an ATM box almost ready to sell. ATM technology is the next generation of the computer networking system, replacing routers and hubs. In my view, the possibility that Whittaker could become a major supplier to networks, which tie desktop computers together, is what makes the stock a home run. The company also owns real estate in Santa Clarita, outside Los Angeles, that is probably worth as much as $5 a share. At $16 a share, Whittaker could double in 24 months.

Sounds like a company in transition. Have another? Wilcox & Gibbs started in 1859 as a maker of sewing machines. Since the 1980s it has diversified by buying distributors of electrical equipment. Rexel, a French distributor, started investing in Wilcox in 1992 as a way of entering the U.S. market. It now owns 40% of the stock, has its own management in there, has sold the sewing machine unit, and is focusing the company. The stock is $7 a share now, or 11 times my estimate for 1994 earnings. I think the company can increase its operating margins and command a higher P/E multiple, which could lift the stock to $17. While on its acquisition spree, Wilcox & Gibbs also acquired the technology to make elastic-coated fibers, or spandex, used in pantyhose. They spun that business off for $8 a share in 1992 as Worldtex. The company had problems when its European operations slowed in recession and when Sara Lee, whom it relied on for 30% of sales, weakened stateside. But this summer sales of pantyhose in France are up over 40% vs. a year ago. Further, the company has a new contract with Jockey and has reduced its exposure to Sara Lee to less than 10% of sales. At $5 a share, I think Worldtex is a screaming bargain.

What's in your technology territory? Sofkey International is a neat company. They started by producing tax software and found out that software was too expensive for consumers. The key to lowering costs, they decided, was distribution. So they went around looking for well-known regional programs and built a network of stores that agreed to sell the rebundled packages at a lower cost. Today they've got a network of 15,000 stores on board in Canada and the U.S., including Wal-Mart. To get critical mass in the titles they can offer, they bought two software makers last year and have set up deals with a lot of fledgling developers. The stock is $13 a share, and management, through stock options, is very incentivized to get it to $20, which I think it can do.

You must own at least one company that has stayed in the same line of business. Tokheim is an old-fashioned manufacturer of gas pumps and hoses now benefiting from technological change. Ever gone to gas stations and paid with a credit card at the pump? Demand for that service, on top of new environmental regulations requiring gas pumps to have vapor recovery systems, is generating a lot of new sales. The company has lost money, but it should break even this year and could earn $2 a share in three years. The stock sold recently for $11.

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART CAPTION: ONE OF HIS PICKS: Whittaker