Even though stocks have rallied since March, David Samra says the international markets still have plenty of running room. "Valuations remain attractive for equities as a whole and even more attractive for equities we are involved with," says the 45-year-old Samra, who has run the Artisan International Value Fund with longtime associate Daniel O'Keefe from their San Francisco office for the past seven years.

By their definition, a company's value is pegged to what someone would pay to own its future cash flows. Part of their intrinsic value analysis, the focal point of their strategy, is to consider potential earnings in a "normal" economic environment. Right now, that would mean after the current struggling economy recovers.

"Usually we look for stocks selling at prices that are at least 30% below our intrinsic value estimates. Now, the stocks in the portfolio are priced at an aggregate of 40% to 45% below our estimate of intrinsic value."

Samra anticipates that the lion's share of his fund's returns will come not from higher levels of business growth but from the improving prices of his stocks as their discount value unwinds. As he waits for that to happen, he says, he finds "realistic causes for optimism" about the economy in general, such as restored order in the credit markets and the apparent end of the emergency in the financial system that began in the second half of 2008. "While the economy has not yet recovered, it appears to have stopped getting worse, and that has been enough to generate some optimism among many investors," he says.

One of his holdings is IGM Financial, a Canadian wealth management firm. Artisan bought the stock in February after it plummeted with the rest of the financial sector. But as investors later became more optimistic, the stock rebounded, rising 50% in the second quarter and reaching its fair value estimate. Its discount evaporated in just a couple of months, and at that point, Artisan sold most of the position.

Sometimes, however, an unexpected development prompts the managers to give one of their stocks a quick boot from the portfolio. For instance, Artisan bought Swiss private bank Julius Baer late last year, but dropped it when regulators in the U.S. and elsewhere cracked down on secrecy provisions in the private banking business.

Usually, however, the holdings in this compact all-cap fund remain in the portfolio for a year or more (it currently holds about 40 names). They are generally not the cheapest stocks by traditional statistical measures such as price-to-book or price-to-earnings estimates, which Samra believes are vulnerable to declining business values and stock prices. But they must fit the fund's desired investment profile of a better-than-average business within a group of undervalued stocks. The fund also looks for companies with sustainable competitive advantages, high returns on capital employed, proven management teams and low debt levels.

Once the managers have compiled a list of attractive businesses, they may follow a stock for months or even years waiting for the gap between their estimate of its intrinsic value and the public value to widen before they move in. That might happen when the stock price drops because of broad market or sector trends or because of a company-specific event such as a change in management.

For example, the fund recently purchased consulting and outsourcing company Accenture during the second quarter. The purchase followed a dip in the company's stock price spurred by concerns that Accenture would face a steep drop in demand for its services and increased competition from large Indian outsourcing firms such as Infosys. Samra says Accenture has successfully defended its turf in this country and maintains a large presence in India as well. Also, it has one of the better client lists in the business. And unlike competitors in the consulting business such as IBM and Hewlett-Packard, the company does not have its own hardware to promote, so it is free from any perceived conflicts of interest. The company has also moved to cut costs and take on projects that do not require heavy initial capital outlays. Although he anticipates a significant decline in the company's higher-end consulting business this year, Samra believes Accenture's revenues should start growing again in 2010 as companies continue to outsource their information technology function to help control costs.

Longtime fund holdings that have outperformed the market recently include U.K.-based Signet Jewelers, which has been able to grow profits and market share as its competitors struggle. Given Signet's healthy balance sheet and proven management team, Samra considers it one of the strongest operators in the industry and a worthy opponent to Zale Corp., its most visible competitor in this country.

After a sharp decline at the beginning of the year, Tyco Electronics posted a 70% gain in the second quarter after the sale of one of its divisions helped shore up its balance sheet. Despite the recovery, Samra still considers the stock extremely cheap. Freight transport company Panalpina Welttransport rose 50% in the second quarter in the wake of unfavorable global trade data.
Although its profits have declined, management has done a good job of cutting costs, maintaining market share and generating cash.

On the other hand, longtime fund holdings Novartis and Covidien have lagged the market this year after outperforming it in 2008. Although the considerable uncertainty surrounding U.S. health-care reform continues to depress the sector, Samra believes that the companies are well run and their stocks very cheap. Arch Capital, a Bermuda-based insurance company, has also lagged the market after losses from Hurricane Ike and regulatory attacks on the tax benefits associated with Bermuda-domiciled companies.

Samra is confident about the company's underwriting standards, its asset management capabilities and its ability to navigate changes in tax law.

Cautious on Emerging Markets
Samra and O'Keefe honed their value hunting skills at Harris Associates in Chicago, where they met in 1997. At the time O'Keefe, who studied philosophy at Northwestern, had just come off stints as a mergers and acquisitions specialist at BancAmerica Securities and before that, as an analyst at Morningstar. Samra had followed a more traditional route from Columbia University, where he had obtained his M.B.A., to a position as a portfolio manager for Montgomery Asset Management.

In 2002, the pair left the Midwest for San Francisco's warmer climate to open Artisan's West Coast office and start the Artisan International Value Fund, as well as, more recently, the Artisan Global Value Fund. "My one regret about leaving Chicago is that the tax rates in California are outrageous," says Samra.

They were compensated for some of that personal financial pain when the fund saw strong inflows, so strong in fact that the managers closed it in early 2007. It reopened to investors in 2008-unfortunately, just in time for the market crash-and finished the year down 30.1%. Still, even though the loss was substantial, the fund beat the 43% loss of the MSCI EAFE Index and helped the team earn Morningstar's International Stock Manager of the Year award for 2008.

Over the long term, the fund's strategy has generally worked well. Between its inception in September 2002 and June of this year, its average annual total return was 14.26%, compared with 8.48% for the MSCI EAFE and 9.52% for the MSCI EAFE Value Index. But there have also been stretches of underperformance such as in 2007, when economically sensitive cyclical companies and emerging markets rallied sharply. Both are areas where the fund treaded lightly.

Samra continues to take a cautious view of emerging markets, in part because the reporting, governance and regulatory practices in these areas make it difficult to pinpoint intrinsic values. In some countries, such as South Korea, consolidated financial statements are not always available. And Russia does not yet recognize that shareholders, not the government, own publicly traded enterprises.

Given the managers' skepticism, it is not surprising that Europe and North America dominate the fund, accounting for 64.1% and 15.4% of equity assets. Pacific Basin countries and emerging markets round out the geographic roster with allocations of 13.2% and 7.3% of the equity assets, respectively.

"The valuations of emerging markets relative to developed markets are not low enough to justify the added risk of investing there," he says. "There are plenty of opportunities elsewhere."

A drop in oil prices prompted the fund to wade into energy stocks earlier this year, an area it wisely avoided in 2008, and it now has positions in Total SA and Royal Dutch Shell. When prices are low, oil companies have little incentive to expand production, and the tighter supplies that result should support the price of the commodity over the long term, reasons Samra. He began buying Total and Royal Dutch Shell during the first quarter of the year when oil dropped to $40 a barrel, well below an estimated production cost of $60 to $80 a barrel.