(FORTUNE Magazine) – Nick Whitridge, 57, spent a year near the ocean's bottom as a Navy submariner. Now, as manager of the $140 million Babson Value Fund, he shows a knack for scouring the bottom of the market to find undervalued stocks that rise after he buys. Babson Value has had a 12.5% three-year average annual return, vs. 7.85% for the S&P 500. From his Boston office, Whitridge spoke recently with Fortune's John Wyatt.

What's your approach to value investing?

We look at the typical value indicators: P/E multiples, price-to-book ratios, and yield. But I would define us as relative value investors, as opposed to absolute. If a stock doesn't meet all our value requirements, it may still have a place in our portfolio. After a stock has appreciated to what appears to be fair value, we won't sell it as long as it is rising as fast as the S&P 500 or declining at a slower rate than the S&P is falling. Some investors leave a lot of money on the table by selling too soon. Annual turnover in the fund is almost glacial--just 20%--and a few of the 40 stocks we own, like Du Pont, Sears Roebuck, and Atlantic Richfield, have been in the fund since it began in September 1984.

What in your portfolio might surprise us?

We own Student Loan Marketing Association (Sallie Mae), and Student Loan Corp., a spinoff from Citibank. Both have been out of favor since early 1993 when President Clinton announced a government program to make direct student loans. Clinton's perception was that these companies, Sallie Mae in particular, made too much money. So he set up a program to take over 5% of the student loan market this year, working up to 60% by 1999.

Investors saw the initiative as total disaster for the student loan stocks--shares plummeted. But at the current price of $37, Sallie Mae is selling at less than the company's total value if you just froze the portfolio now and never bought another loan. And even if the government program grows as quickly as Clinton intends it to--an unlikely prospect in my book--that still leaves 40% of the industry in private hands. I think Sallie Mae could be at least $55 in 12 to 18 months. Student Loan Corp., though a far smaller company, is well undervalued at $24 and has the added attraction of being a takeover candidate, possibly by Sallie Mae.

You own several large retailers. What's the story there?

I think a number of retailing stocks are depressed in part because investors fear the Fed is going to throw the U.S. into recession. But I'm expecting the economy to continue expanding--employment and personal income figures look pretty good.

Sears Roebuck has been streamlining since 1993, when it began selling Dean Witter Discover, the Sears Tower in Chicago, and Coldwell Banker. It has just announced plans to sell Homart Development Co.--estimated to be worth $2.2 billion. These asset sales are providing Sears with the capital it needs to focus on the revitalized retail business. I think the $47 stock, at less than nine times our 1995 earnings estimate, should be worth at least 12 times earnings, which would make the stock $65--and that's still a discount to the market multiple.

Right now Kmart reminds me of Sears a few years ago--a company that has no friends. It sold Pace Membership clubs to Sam's Clubs. It has spun off majority stakes in OfficeMax and Sports Authority, and should do the same with its book chains and Builders Square. The deals enable Kmart to retain minority holdings in these operations while making it easier for analysts to value the assets. As with Sears, the asset sales are giving Kmart the capital it needs to continue revamping stores. The stock is $14, ten times our earnings estimate for this year. I think it could be $19 in a year.

You have four banks in the portfolio. Tell us about one.

I like Chase Manhattan, which, at $34, sells at just five times our 1995 earnings estimate. There is no dynamic, easily defined growth case for Chase. But as one of the leading money-center banks, it should perform at least as well as the others, and when it is selling at a P/E of five, how badly can you get hurt? That P/E is just absurdly low for a company whose earnings have typically been higher than estimates.

You own IBM. Is a turnaround in progress?

Yes. I think it took a leader like Lou Gerstner coming in--someone who was outside the ingrown IBM culture--to start making the moves necessary to turn the battleship around. The company is doing a better job in its personal computer business. Mainframe and midrange computers are selling better than expected. The stock is $76, 11 times our 1995 earnings estimate. I think it could be over $100 in a year.