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Betting on a Revival of Foreign Small Stocks

NEW YORK ( TheStreet) -- After stagnating for years, economies in Japan and Europe are showing a bit of life. During the second quarter of this year, Japan's gross domestic product grew 2.6%, while the eurozone eked out a gain of 0.3%.

Economists expect the expansion to continue. To benefit from brighter times, investors can try funds that focus on foreign small-cap growth stocks. Many of those are domestic businesses that should surge if local economies continue growing.

While foreign stocks have rallied lately, they still seem like bargains compared to U.S. counterparts. The portfolios of U.S. small growth funds have price-earnings ratios of 22, compared to 18 for foreign small/mid growth funds, according to Morningstar.

To bet on an overseas boom, consider a fund with a relatively steady track record. Top choices include American Century International Opportunities (AIVOX), Oberweis International Opportunities (OBIOX), Thornburg International Growth (TIGAX) and Wasatch International Growth (WAIGX).

Wasatch has delivered strong returns by focusing on high-quality companies. During the past five years, the fund returned 13.2% annually, topping 94% of peers. The portfolio managers search for companies with high returns on equity and strong balance sheets. The aim is to find businesses with significant competitive edges.

A holding is Seria, a Japanese chain that operates 100 yen stores, which are somewhat similar to dollar stores in the U.S. While typical competitors record profit margins of less than 2%, Seria has 8% margins, says Wasatch analyst Linda Lasater. "They run lean operations that are head and shoulders above the competitors," says Lasater.

Another holding is Domino's Pizza Group PLC (DPUKY), which owns and franchises outlets of the Domino's (DPZ) pizza chain in the United Kingdom. Helped by an expansion into Germany, the company can double its size, says Lasater.

Another strong performer is Oberweis International Opportunities. During the past five years, the fund returned 8.7% annually, topping 80% of peers. Portfolio manager Ralf Scherschmidt looks for stocks that can do better than Wall Street expects. In some cases, he buys powerhouse companies that seem likely to beat earnings forecasts. Other times, he takes troubled businesses that can turn around.

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