The 'unloved' ASX shares ready to explode, now 50% down on historical prices

There are a bunch of ASX shares that are now trading at half price compared to historical benchmarks, and are just ready to burst.

That's the opinion of Datt capital chief investment officer Emanuel Datt, who pointed out the S&P/ASX Small Ordinaries (ASX: XSO) index is now at a "substantial divergence" from the All Ordinaries Index (ASX: XAO).

"At present this discount is at about 30% according to our research. This compares to historical norms of the small cap index typically trading at a premium of circa 20%," he said.

"Accordingly, in terms of relative valuation there is a 50% divergence from the historical norm."

And whenever such a huge discrepancy has occurred, according to Datt, a period of "strong returns for small cap investors" has followed, as the market reverts to its average.

Even Australia's huge sovereign fund, the Future Fund, recently entered the fray as it called ASX small caps as a "persistent alpha opportunity".

'Intensive research' for 'strong idiosyncratic returns'

According to Datt, many "unloved" small-cap stocks have potential for "strong idiosyncratic returns" that are independent of macroeconomic factors.

"The size of these companies means they fall under the radar of many or most institutions.

"There is much less investor interest generally in this sector and therefore greater opportunity of strong returns for those investors who believe in conducting intensive research in this sector."

So how do investors find the right small-cap stocks to buy?

Proper research is imperative, said Datt.

"As investors, we must take time to understand not only the technical aspects of a company's performance but also how the macro and micro factors affect the fundamentals of any company.

"Investors should look for invisible data that lies outside the standard stock screening software, using primary data."