Finding hidden gems in dirt-cheap foreign stocks

Troubles in Europe and China are making foreign stocks dirt-cheap. Prospect for the ones that don't deserve to be.

(MONEY Magazine) -- Overseas markets are full of anxiety -- and rightfully so.

The European debt crisis plunged much of the region into recession and pushed stocks into a bear market in February 2011.

In China, which has been driving the global economy, growth is cooling more rapidly than expected, threatening business activity throughout Asia, including Japan. Since the fall of 2010, when the slowdown took hold, Chinese shares have sunk 27%.

No wonder foreign stocks, which have historically traded at a slight premium to U.S. shares (based on a conservative gauge of price/earnings ratios), are now at a 34% discount.

That's far cheaper than they were in the Asian currency crisis of 1997 or the Latin American debt debacle of the '80s. And in the decade after those panics, stocks in the affected regions trounced U.S. equities.

"Non-U.S. markets are strikingly cheap," says Charles de Vaulx of International Value Advisers.

There's no guarantee, though, that low-priced stocks won't fall even more, especially if the global economy worsens.

So as you bargain-hunt abroad, stick with blue-chips that have strong enough balance sheets and prospects to withstand another storm in the short run but that are attractively priced for the long term. Here are some examples:

Defensive European stocks

In Europe, plenty of Steady Eddie shares have been unfairly punished because of the region's woes.

Take Heineken (HINKY), Western Europe's biggest brewer. The stock is down 17% in the past year largely because, well, Heineken is Western Europe's biggest brewer.

Never mind that alcohol stocks have historically held up in tough times. Or that more than a third of the company's sales come from the faster-growing emerging markets. That's one reason its revenues and profits have grown throughout the continent's turmoil.

"Heineken offers stability, a great global footprint, and plenty of room to grow," says Camille Humphries-Lee, part of the team that oversees the MFS International Value Fund (MGIAX), which owns the stock.

Shares of U.K.-based wireless phone giant Vodafone (VOD) trade at a P/E of 10.8 based on projected profits, about a 15% discount to the global telecom sector. While troubles in Spain and Italy pose a threat, the company now generates around a third of its sales from Eastern Europe, the Middle East, Africa, and Asia.

"The firm's wide geographic operations help in the current economic malaise," says Morningstar analyst Allan Nichols.

You can own Vodafone and other undervalued foreign shares through Dodge & Cox International Stock (DODFX), a MONEY 70 pick. For even broader exposure to cheap overseas stocks, there's iShares MSCI EAFE Value. (EFV)

A safer way to play Asia

Want to bargain-hunt in Asia but prefer not to own individual stocks in the emerging world? The deceleration in China has helped create even bigger opportunities in Japan, China's biggest trade partner. Sluggish exports have helped send equities there falling more than 25% since last March.

P/E ratios for Japanese stocks are 60% below their average since 1995. By comparison, valuations for Chinese equities are down by around a third. Rob Taylor, co-manager of Oakmark International (OAKIX), likes Toyota (TM), which derives 45% of revenue from the emerging world (the stock is a top holding in his fund). The automaker also expects North American sales to jump by a quarter next year, as it regains market share lost after last year's tsunami.

Another area of growth in the Land of the Rising Sun is wireless data, as smartphone usage there tripled in 2011. Enter NTT DoCoMo (DCM) , which controls half of Japan's market.

NTT should see healthy growth in its margins despite Japan's economic malaise, says MFS' Humphries-Lee, whose fund owns the stock. You can gain exposure to both companies through iShares MSCI Japan (EWJ), which counts Toyota and NTT among its top 15 holdings.