This Fidelity manager has crushed the S&P 500 since 1989—here's his advice for investors

There isn't a Hall of Fame for mutual fund managers. But if there was, Joel Tillinghast would be getting buzz as a first-ballot inductee.

Since his fund, Fidelity Low-Priced Stock, launched in December 1989, investors have enjoyed an annualized total return of about 13%. That smashes the roughly 9% turned in by the fund's benchmark Russell 2000 index, which tracks the performance of small-company stocks, and is well ahead of the S&P 500 index's just over 10% return over the same period.

The difference in performance is bigger than it seems. Had you invested $1,000 in Low-Priced Stock on Tillinghast's first day, you'd currently have more than $57,000, according to data provided by Morningstar Direct. The same investment in an S&P 500 index fund would be worth about $25,000.

Tillinghast picked up three co-managers in 2016 and 2017, and two of them — Morgan Peck and Sam Chamovitz — will take the helm when Tillinghast steps down at year end. They will no doubt look to continue a strategy of picking undervalued small and midsize company stocks they believe can deliver outsize long-term returns to shareholders.

In the meantime, Tillinghast chatted with CNBC Make It about lessons in stock-picking, keys to long-term investing success and the changing landscape for retail investors.

CNBC Make It: Your fund's mandate has changed some over the years, but the approach to picking stocks has remained the same. How would you describe your strategy?

Tillinghast: We look for stocks that trade at a discount to their intrinsic value. And we tend to search in the places that are least in the public eye. So they're probably not the things that are making up the lead stories of CNBC or The Wall Street Journal. They're hidden in the back pages.

Those would be small and mid-cap stocks [those with small and medium market capitalizations], domestically and globally. Anything that is sort of neglected enough that it might be undervalued.

How do you define a value stock? What makes a certain company undervalued?

In a perfect world, what I'm looking for are companies where earnings turn into cash, which can be returned to shareholders, and looking for companies where it's not dangerous or ridiculous to think about what the earnings power will be in five years or 10 years. The fund is a long-term focused fund, because value comes out over the long term.

How do you differentiate yourself from other small-company stock funds, many of which tend to hew closely to the benchmark index?

If you start with the Russell 2000 benchmark, we're different in that we have a long tail of mid-cap stocks, and even a few very large cap stocks. One of the most notable features is that we have a lot of international small caps.

Japan is a particular area of interest, and Sam Chamovitz, who's half of the team that's taking over the fund, spent several years working in Japan. And so we have the advantage of more attention to smaller [Japanese] companies that are not well followed by brokers, or anyone for that matter.

You've helmed the fund since 1989. How has your approach to investing evolved since then?

I think anybody who doesn't change is missing the point. The fun thing about investing is you're constantly learning — sometimes by losing money, sometimes by making money when you didn't expect to. The ones where you lose money tend to stick with you.

There's so much more information through news media and Wall Street. I think it's a good thing all this information is out there, but the bad news is people have so much short-term information, so many data points, that they are distracted from the necessary work of thinking about the business quality. They're spending less time thinking about the barriers to entry, the quality of management, whether a business is doing something that customers think is special.

The other major change is more business models go away. If you didn't know about the internet, you'd have thought that every cultured family would have an encyclopedia and a piano in their house. Today, they have neither. Their computer does it for them. Business models are changing because of technology, and that is different. And so someone who is trying to look out five years has to engage with that.

What's a lesson have you learned from a big winner?

I bought Monster Beverage — at the time they were Hansen's Natural and were a juice drink company — because I liked that they were trying an energy drink. I like companies that try a lot of experiments. They may not always work, but they do try a lot of things. And I think Monster is very innovative that way.

Tillinghast bought in 2001 at about $4 per share — accounting for splits, that's more like 4 cents a share. Now it trades for $58.

Warren Buffett — maybe the world's most famous stock picker and value investor — tells retail investors to gravitate toward index funds. Do you agree?

You have to think about where you have an advantage and what you're trying to do in the market.

If you don't have any advantage in assessing value; if you don't have any advantage in telling whether things are much better than people think; and if you're not particularly good at imagining what the growth will be over three to five years, a passive fund is right for you.

Even active investors should think about what is it that they do that adds value beyond the index.

Still, there are mutual fund managers like you who can and have beaten indexes over long periods. Clearly it's important to look at track record, but beyond that, how can I choose a fund with a worthwhile manager?

You should look for one that clearly articulates what it is that they're doing that's special.

If I talk with [Fidelity Contrafund manager] Will Danoff, he tells me, "I want the best-in-class in growing industries." He wants a very short list of the best management teams that are best positioned in growing industries.

I am looking for stocks that are fairly undervalued hoping that they're not just 10% undervalued. I want a lot more undervaluation than that — especially in the fullness of time where you come back five years later and say, "Oh, it really was worth a lot more than you paid for it."

I would look for a fund where the manager clearly articulates that. If they say, "I do a little of this, a little of that" — no. Put it in the index fund or find a better manager.

What's your advice for young investors? How can they invest like Joel Tillinghast?

Think about your character and what works for you. My patience is an asset for me, but would be a total liability for a momentum investor. For some people, there's so much aggravation and worry that putting it in index funds is the best approach.

To invest like me, take a long view. Think about what earnings will be in five years. Take a while to consider your possibilities. If you've got a truly fantastic long-term story that is truly undervalued, make it bigger — not necessarily 20% of your portfolio, but it's good to make it important if you think it's big.

It would probably have a lower [price-to-earnings ratio] than the market, high free cash flow yields [a measure of a company's free cash versus its market value], and it would probably have growth, because the company was doing something special that clients really liked.

I'm comparing price and value all the time. I think lots of investors don't really do that. You have to know to be patient, and to have above average patience when you think something good is happening.

This interview has been edited for brevity and clarity.

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