Some managers ferret out value in stocks that stumble but have recovery potential

Much has been written about the demise of the American hero. In the world of corporate mythology, however, few would deny Lee Iacocca a place in the pantheon of heroes, turning Chrysler around as he did.

Slightly less well known are the heroic exploits of Victor Palmieri, who turned the assets of the bankrupt Penn Central Railroad into a thriving company. Mr. Palmieri has recently been tapped to try the same miracle with Baldwin-United, the high-flying insurance conglomerate that recently went into Chapter 11 bankruptcy.

The phenomenon of dramatic corporate turnarounds is not a recent development. In 1919, William C. Durant turned a weak General Motors - the Chrysler of its time - into one of the giants of American industry.

If such men are lauded as heroes, the people who have faith in these executives' abilities and who invest in their companies while they are still downtrodden are also minor heroes, as they are frequently able to achieve some of the most impressive stock market profits.

Anyone who invested in the financially troubled Chrysler back in 1981, when the stock was selling at less than $3 a share, would be holding a share worth some $30 as of mid-October. (Chrysler stock rose as high as $35 during the past year.) In fact, one of the most successful mutual funds - Fidelity's Magellan - racked up its impressive gain of over 100 percent last year by having a large block of Chrysler stock in its portfolio.

Such rosy results have not been lost on the professional investment community which creates and manages mutual funds. Recently, two mutual funds have been launched to take advantage of what Lord Abbett & Co. refers to as ''unusual capital appreciation.'' In the spring, Lord Abbett, well known for its Lord Abbett Development Fund - one of the original OTC (over the counter) mutual funds - brought out its newest offering, the Lord Abbett Value Appreciation Fund (known within the company as LAVA). And last autumn, Merrill Lynch introduced its Phoenix Fund, which is specifically designated to invest in high-risk strained companies.

At Lord Abbett, John Campbell, national sales manager, explains that his firm's newest fund differs markedly from mutual funds that invest in flat-out bankrupt companies which might experience a revival. In Campbell and Lord Abbett's view, the entire country and its economy are experiencing a macro-turnaround, and the new LAVA fund will find companies that are taking part in it.

Another area in which LAVA will specialize, he says, are ''quality stocks that stumbled.'' An example would be Johnson & Johnson after the Tylenol crisis. He recalls that J&J stock fell between 25 and 26 percent after the distressing news broke. But such investments are not looked at only by LAVA. Similar investments are made by the Phoenix Fund, which does not always require that companies be in as dire straits as a Chrysler. For instance, Phoenix purchased Texas Instruments stock in June, after the company announced a more than $100 million loss for the second quarter resulting from a severe drop in its sales of home computers and software.

But Phoenix is more heavily invested in both the stocks and bonds of bankrupt companies like Braniff International and Wickes Corporation - Phoenix holds bonds of each of them - and those that are on the brink, like General Public Utilities. Lord Abbett's Value Appreciation Fund takes a more moderate course, investing in corporations that have suffered or deteriorated from the general economic environment of the last decade and should improve markedly as a national turnaround evolves.

Lord Abbett delineates eight areas of change which it uses as precepts that will return certain companies to growth. They are changes in quality; demographic changes; management-labor changes that could make the company more profitable; a decline in interest rates; executive changes in management at the highest level; a crisis that has changed the perception of the company - like the Manville Corporation asbestos crisis; changes in the farming situation brought about by payment in kind (PIK) legislation; and change through deregulation as in banking and energy. Finally, it also expects change due to lower inflation.

''Demographically, we are going to have a baby boom,'' says Mr. Campbell, noting one of Lord Abbett's eight precepts. ''And the old folks are going to be a big part of the demographic composition. That means we have taken a position in Kodak. Kodak stock has been murdered recently, and you would find it in our portfolio.'' (With a baby boom, people tend to take more photographs.)

Campbell also observes a ''return to quality and the work ethic in America. We are riding on the quality wave,'' he says. On that basis, Lord Abbett has made such investments as Worthington Industries, a specialty steel manufacturer, and Sun Electric, a firm that makes equipment to check out automotive engines.

Both Phoenix and LAVA have positions in Manville, the big buildings materials company that filed for Chapter 11 after an inundation of asbestos suits. Such an investment falls under the category of a crisis - an unplanned aspect of business forces - striking an otherwise wholesome company.

Since its inception Phoenix Fund has risen 26.31 percent, with a total investment return of 28.83 percent. LAVA's results so far in its short period of existence are not significant. Campbell is adamantly optimistic. ''What you have here are the same ingredients that fueled the market in 1922, and that market went up 500 percent. After World War II there were the same conditions. And as the companies take advantage of the changes going on in the economy, we see this portfolio as one of the happiest for investors.''