(MONEY Magazine) – With U.S. stocks racking up returns of 20% to 35% so far this year, you might figure only a lunatic would bother to seek superior gains abroad. But think again. "It's a virtual slam dunk that many foreign markets will outperform the U.S. over the next 18 months," says Eric Fry, president of Marin Capital Management, a San Francisco international investment firm. Numerous European stocks now trade at price/earnings ratios 20% to 45% below those of their overheated U.S. counterparts--prices so depressed that many analysts predict that select overseas shares could zoom 30% or more by the end of next year. But the most tantalizing gains may come in volatile emerging markets like Latin America, where stocks were hammered for 22% losses last year. Intrepid investors willing to venture into these fast-developing regions could grab returns in individual stocks of 65% or more.

By contrast, the U.S. market seems to have its best gains behind it. Money's chief investment strategist, Michael Sivy, thinks the Dow Jones industrial average might rise to 5000 by year-end, only to plummet to 4000 or lower within 18 months of hitting that peak. Given the fatter opportunities for gains in foreign shares, investment pros recommend that you start moving 20% to 25% of your stock portfolio into international funds and stocks, including emerging markets.

Finding the best values overseas won't be as simple as throwing darts at a world atlas, however; for the next year prospects vary widely among the world's more than 30 stock markets. And if the dollar's sharp rise continues-it gained 10.7% vs. the Japanese yen in August-U.S. investors could lose some of their gains to the strengthening greenback. (A robust dollar erodes U.S. investors' returns.)

Before you start snapping up foreign funds or stocks, you should first familiarize yourself with the international landscape. Here's a quick tour:

Europe. The outlook is largely positive, especially for smaller countries such as Finland, the Netherlands, Spain and Sweden, where shares are trading for 20% less than U.S. stocks when you consider the respective companies' earnings power. European bourses also figure to get a boost from declining interest rates. In late August, for example, Germany's equivalent of the Federal Reserve Board trimmed short-term rates by half a percentage point.

Japan. The forecast is much cloudier for the Japanese stock market. Analysts note that the Bank of Japan seems determined to revive the recession-ridden economy by pumping up the nation's money supply and cutting interest rates. If that strategy works--and no one can guarantee that it will--the Nikkei-225 stock average could rebound 17% by early next year to 21000 from 18000 recently (which would still put it 46% below its December 1989 high of 38916). If growth remains stagnant, however, stock prices could retreat 10% or more from current levels. Currency traders also believe the dollar could edge up as much as 12% against the yen, which would dampen American investors' returns even if the Nikkei soars. In the face of such uncertainties, most experts advise against making bets on the broad market. "People should consider cherry picking stocks of top technology and capital-goods companies, which could prosper even if stock prices overall don't," says Merrill Lynch senior international strategist Douglas Johnson. (For a look at several Fidelity funds that are bullish on Japan, see page 55.)

Emerging markets. "The very beating that many emerging-market shares took last year has made them especially attractive buys now," says Leila Heckman, managing director of Global Asset Allocation at Smith Barney. Heckman is particularly bullish on stocks in Argentina, Brazil, the Philippines and Singapore. She advises caution for now in Mexico, however, since political uncertainty and a fragile banking system still pose significant risks for the market.

To provide you with the top investment picks around the world, MONEY consulted more than three dozen international analysts, fund managers and other experts. Their 13 recommendations--seven funds and six stocks--are presented below. Beginning with the least risky, they include diversified international funds, diversified emerging markets funds, regional emerging markets funds and individual foreign stocks. (For performance figures on each of our experts' 13 choices, see the table on page 141.)

DIVERSIFIED INTERNATIONAL FUNDS

These funds, which lower risk typically by spreading their assets among 20 or more large and small markets around the world, should make up the core (say, half to three-quarters) of the 20% to 25% of your portfolio you devote to international holdings. Ken Gregory, editor of the monthly newsletter No-Load Fund Analyst ($195 a year; 800-776-9555), recommends $3.4 billion Vanguard International Growth, whose manager Richard Foulkes, 50, has run the fund capably since 1981. Foulkes currently has 51% of his 178-stock portfolio invested in Europe, where he favors growth companies, such as $6.4 billion Dutch brewer Heineken, that are cutting costs and thereby increasing profit margins. In Japan, where he plans to build his current 24% stake to 35% or so over the next six months, Foulkes is snapping up retailers, including $33.6 billion supermarket chain Ito-Yokado, that stand to thrive when the economy revives. Says Foulkes: "Retailers should be the first to benefit from a pickup in Japanese consumer spending."

For solid long-term performance, Gregory also suggests $6.3 billion T. Rowe Price International Stock. "The fund's not likely to shoot the lights out in any one year," he says. "But over the years it'll give you your money's worth and then some." The proof: The fund has beaten the average return of its peers in each of the past 10 years. The 320-stock fund, which is run by Martin Wade, 52, and seven other managers, has half its assets in Europe, where his holdings include major worldwide companies such as Netherlands-based $434 million publisher Elsevier and $105 billion Royal Dutch Petroleum. The fund maintains a small position in Latin America (5.5% of assets) that includes a few select Mexican stocks that Wade and company consider exceptional values. Among them is $5.1 billion Telafonos de Maxico, recently down 58% from its 1994 high.

For a completely different kind of diversified international fund, Thurman Smith, editor of Equity Fund Outlook ($115 a year; 617-397-6844), recommends $330 million GAM International. "GAM is one of the few funds that has survived tricky markets by shifting adroitly between stocks and bonds," says Smith. Manager John Horseman, 37, now has 58% of the fund's assets in government and convertible bonds, primarily German, Dutch, Swiss and Austrian issues yielding 6% to 10.75%. Reason: He expects long-term rates in Europe to continue to decline. As for the third of the portfolio that is now in stocks, Horseman mostly prefers financial issues such as $2.3 billion Spanish bank Banco Popular Espanol and $8 billion Lloyds Bank in the U.K. that would also benefit from falling rates.

DIVERSIFIED EMERGING MARKET FUNDS

You should consider allocating another 5% to 10% of your equity portfolio to funds that buy a broad range of emerging markets that might produce annual stock gains of 15% to 20% over periods of five years or more. These portfolios are not for the faint of heart, however, since their returns can swing wildly from one year to the next. For example, $315 million Lexington Worldwide Emerging Markets Fund gained 63.4% in 1993 only to tumble 13.8% last year.

Sheldon Jacobs, editor of the No-Load Fund Investor ($119 a year; 800-252-2042), likes $1 billion Montgomery Emerging Markets, which holds 300 stocks in 33 countries from Venezuela to Ghana to Hong Kong. Managers Josephine Jimenez, 41, and Bryan Sudweeks, 40, have invested the fund's biggest stake (55% of assets) in emerging Asian economies. Three of the fund's largest stockholdings-$293 million Arab Malaysian Merchant Bank, $379 million United Engineers (Malaysia) and $890 million hotel and casino operator Resorts World-are all in Malaysia, where Jimenez believes the booming economy (recent growth rate: 8.6%) could propel stock prices to healthy gains. Lately, the fund has also been adding to its position in Latin American shares, now 25% of assets. Says Jimenez: "After the free-fall in the first half of the year, Latin American markets like Venezuela and Argentina are ready for a comeback."

John Rekenthaler, editor of Morningstar Investor ($79 a year; 800-876-5005), favors $2.2 billion Templeton Developing Markets. "With international funds, it pays to buy from a fund company known for foreign investing," says Rekenthaler. "That makes Templeton hard to beat." Along with diversifying among 381 stocks in 29 different countries, renowned value investor J. Mark Mobius, 58, will keep a substantial portion of the fund's assets in cash when he's unable to find good cheap stocks to buy. Lately, though, he's reduced his cash position (from 32% in March to 25% now) and shifted the money into beaten-down stocks in such Latin American countries as Mexico and Argentina, where the fund's holdings have recently grown from 15% to 21%. Among his recent purchases are shares of $2.6 billion Mexican cement maker Cemex. Although the stock lost more than 60% of its value in the wake of the peso's December 1994 drubbing, Mobius believes the company still has excellent long-term prospects.

REGIONAL EMERGING MARKET FUNDS

These specialized funds, which limit their investing to specific areas such as Latin America or the Pacific Rim, offer the greatest potential rewards--and the most risk. Since 1985, Latin American equities have gained 23.1% annually. But it's been a tortuous ride. Last December, for example, Latin American stocks plunged 22%. Says Robert Bingham, investment adviser at Bingham Osborn & Scarborough in San Francisco: "To guard against sudden market swings, you should dollar-cost average into these funds."

Two regional funds Bingham recommends for investors willing to hang on for five years or more are $2.1 billion 150-stock T. Rowe Price New Asia and $580 million 63-stock Scudder Latin America. T. Rowe Price New Asia co-manager David Warren, 38, is adding to the fund's already substantial (26% of assets) holdings in Malaysia, where he's grabbing fast-growing stocks. One example: $306 million mobile telecommunication firm Technology Resources Industries, which has gone from a mere handful of subscribers to some 500,000 in just three years. "Rather than slow down and install millions of telephone lines," says Warren, "the country is skipping straight to mobile phones." Meanwhile, Scudder Latin America co-manager Ed Games, 58, is betting on Brazil (39%) and Mexico (31%). But instead of jumping from country to country in search of the hottest performers, the fund employs a long-term buy-and-hold strategy; its 22% portfolio turnover is roughly a third of the average international fund's. Says Games: "We did a lot of our buying earlier in the year, after some solid companies had been beaten down 50% or more in dollar terms." Large Mexican holdings include $2.5 billion retailer Cifra, which is down 65% from its 1994 high.

INDIVIDUAL STOCKS

The six stocks below-projected to return 23% to 65% over the next 12 to 18 months-each trade as an American Depositary Receipt (ADR) on the New York Stock Exchange.

Larry Jeddeloh, chief investment officer of the TIS Group, a Minneapolis investment adviser, is bullish on Japanese technology stocks, particularly exporters, whose products will be more affordable to Americans as the dollar strengthens. He recommends two such top picks: $5.8 billion Kyocera (KYO; $177.25; 0.6% yield) and $90.6 billion Hitachi (hit; $106; 1.2% yield).

Kyocera, which is the world's largest producer of ceramics used to package integrated circuits, derives 25% of its sales outside of Japan. At home, Kyocera's 22% stake in DDI, Japan's second largest phone company, will mean increased sales of the phones and phone parts it also sells. Jeddeloh calls Kyocera "a terrific, pure play on world technology." He predicts that the stock can reach $240 in 12 months for a total return of 36%.

A world leader in the semiconductor industry, diversified manufacturer Hitachi is also a renowned producer of everyday consumer goods such as air conditioners, microwaves and refrigerators. "When Japanese consumers start spending again, these are exactly the items they'll snap up," says Jeddeloh, who expects the stock to hit $140 within 12 months for a 33% gain.

Vanguard International Growth manager Richard Foulkes recommends Netherlands-based $41.5 billion Philips Electronics N.V. (PHG; $45.25; 1.8% yield), the world's second largest electronics firm. A maker of everything from CD players and televisions to semiconductors, Philips gets 46% of its sales outside of Europe. "I like the fact that management has been slashing costs," says Foulkes. Since taking over in 1990, CEO Jan Timmer has boosted earnings an average of 39% a year by closing inefficient plants, selling extraneous businesses and cutting employment. Foulkes says the stock could fetch $60 within 12 months for a 34% total return.

Frank Jedlicka, 64, manager of $85 million Loomis Sayles International Equity Fund, uses benchmarks such as positive earnings momentum and low P/E ratios to identify countries where stocks are compelling buys. His system has worked over the past year: Through Aug. 1, his fund is up 13.2%, placing it in the top 7% of international stock funds. Three of his current favorite stocks: Brazil's $770 million Aracruz Celulose (ARA; $12.25; 2% yield), Spain's $20 billion Repsol (REP; $32.50; 3.4% yield) and Canada's $3.6 billion Magna International (MGA; $45.25; 1.7% yield).

Aracruz Celulose is the leading supplier of bleached eucalyptus pulp to the paper industry, with a 20% share of the worldwide market. Analysts say that rising pulp prices and expanding demand in recovering economies around the globe could power the company's earnings 25% to 30% over the next three to five years. Jedlicka believes that combination could propel the stock to $20 within a year for a 65% total return.

So far this year, Spanish oil and gas producer Repsol has managed to increase earnings by more than 20%, primarily because of soaring profits in its chemicals division. With analysts predicting that the company can continue to grow profits by a steady 15% annually over the next three to five years, Jedlicka is convinced Repsol shares can rise to $40 over the next 12 months for a 27% advance.

Canada's Magna International, a parts maker for cars and light trucks, has 84 manufacturing plants located in Canada, the U.S., Europe and Mexico. The company's ability to produce steel parts for car bodies and transmissions at prices 20% to 30% lower than its competitors recently won it new contracts from Chrysler, Ford and General Motors that analysts believe could add $355 million in sales by 1998 and help boost profits 18% annually the next two to three years. On the strength of those earnings, Jedlicka says, Magna's shares could motor to $55 and a solid 23% gain within a year. Sums up Jedlicka: "Foreign economies are recovering and international stocks are attractively priced--it's a great time to go bargain hunting abroad."

Reporter associate: Duff McDonald