BARGAINS KEEP FIRM HEALTHY : FUND MANAGER CAPITALIZES ON SHORT-TERM LOSSES.

Byline: Timothy Middleton The New York Times

Edward C. Mitchell thrives on bad news.

When the stock of Compaq Computer fell 17 percent this month after the company predicted lower earnings, Mitchell, the manager of the Invesco Total Return fund, didn't sell the shares the fund has owned since 1991. Seeing a bargain, he bought more.

He is doing the same thing with bonds, having increased the holdings of Total Return as interest rates have risen and bond prices have fallen.

``We always look for opportunities created by short-term events where the volatility may not be justified,'' Mitchell said, explaining his strategy.

A career employee of Invesco since earning his MBA from the University of Colorado in 1970, Mitchell, who is 54, has managed Total Return since its inception Sept. 30, 1987.

Over the past five years, the fund has returned an average of 13.27 percent, ranking fifth among the 42 asset allocation funds identified by Morningstar, the fund tracking company in Chicago.

His style, forged in the bear market of the 1970s and reinforced by the market crash that overtook him less than three weeks after his fund began, is to buy stock with a view toward long-term growth, but at a discount.

He buys only large and midsize companies with at least 10 years of seasoning in the market and uses quantitative analysis to identify the 125 or so most undervalued companies.

The $897.3 million fund has about 65 percent of its assets in stocks and 27 percent in bonds, with an average maturity of 7.2 years. The other 8 percent is in cash.

The fund holds about 60 stocks, and the turnover is typically 20 percent to 25 percent a year. Some shares have been in the fund since it was started.

``One feature of our management style is that we don't have a high turnover,'' Mitchell said. The positions of the fund are spread fairly evenly among its stocks, with each accounting for roughly 1.5 percent of assets.

His goal is to deliver average returns a point or two above Standard & Poor's 500, but with what he considers less risk because of his strategy of buying ``value'' stocks, balanced by the fund's fixed-income holdings.

``The result is that we underperform in very strong markets, but we're less volatile in down markets,'' he said. The fund has beaten the S&P index in three of the past five years.

Mitchell said he was taking advantage of the volatility in the market this year by adding to the fund's holdings of several stocks, including Compaq.

When Compaq warned this month that its earnings were weakening, the shares fell to the upper $30s from about $50. Invesco Total Return first bought the stock in 1991, at prices of $8 to $11, and it has continued to buy more when prices have softened, resulting in an average cost per share of $29.50.

Mitchell said Compaq was selling at just 10 times his estimate of 1996 net income, a steep discount to the multiple of 16 for the whole market.

``While the short-term earnings may be disappointing,'' he said, ``the longer-term prospect of this company in terms of its market position is excellent.''

Mitchell was a big fan of the NBD Corp. of Detroit, buying the stock at an average cost of $32.375 over several years.

The banking companies have since merged to form the First Chicago NBD Corp., and when its shares recently fell to the high $30s from the low $40s, Mitchell bought more.

``It's selling at 8.7 times 1996 earnings, and it's yielding 3.7 percent, which sounds very generous in today's market of skinny yields,'' he said. The consensus estimate is that the company will earn $4.30 a share this year, up from $3.45 in 1995.

Mitchell said the recent drop in the stock was a result of the increase in interest rates, creating another opportunity for investors to convert short-term market jitters into long-term capital gains.

``With the trend toward consolidation in this industry,'' he said, ``the merger makes the surviving entity a stronger one.''

Mitchell doesn't always wait for a stock to dip to buy more shares of a company he likes. Shortly after Total Return was started, Mitchell began buying American Home Products at about $24. The stock has risen to about $103 a share, but that has slowed his buying, not stopped it.

``I haven't been as aggressive recently, but American Home still looks attractive based on the way it is growing,'' he said. ``This is like a growth stock. It's trading at 18 times earnings, which is close to the market multiple, but the return on equity is close to 40 percent, vs. 16 percent for the S&P average.''

American Home is broadly diversified in health care and household products, from the Advil pain reliever to the Chef Boyardee line of canned goods. It distributes about 60 percent of its profits as dividends and invests the balance in its own growth.

Mitchell said that based on a comparison with the S&P 500, American Home managed to combine an above-average dividend yield, now 2.95 percent, with a rate of investment in its own business that is about 60 percent above the market average.

While the price is fairly rich by value-investing standards, ``we don't define value necessarily in the conventional way, which focuses on low price-to-earnings and price-to-book and high yield,'' he said.

``High-return companies, all things being equal, are more desirable because of the internal compounding of the growth in earnings, dividends and assets,'' he added. ``Here you can buy, at close to a market multiple, a company that has proved it can grow earnings and dividends a heck of a lot faster.''