WHY WE BOUGHT STOCK IN DIAMOND HILL (DHIL)

Written By Austin Crites

Aurora Financial Strategies recently purchased shares of Diamond Hill (DHIL) for clients in individual stock strategies

  • We believe DHIL has upside potential of 148% versus downside potential of 37% based on our scenario analysis and price at the time of writing

  • The company has an identifiable economic moat, quality balance sheet, and attractive margin of safety

    Why did we make this purchase?

    We believe the stock is worth at least $220 but it trades at only $136 as I’m writing this blog. To arrive at this number, we perform detailed financial analysis to estimate the future cash flows of the business. Successful investors buy assets at a significant discount to fair value. By our estimate, the stock should trade at a price 62% higher than it does today. We think it could do much better, but this estimate does not depend on some of the improvements we expect to see in the business. Should the business improve as we believe it should, our modes suggest the value is more like $337 (148% upside potential), a tidy profit.

    What does this business do?

    Diamond Hill is a financial company that gets paid to invest money on behalf of individuals and institutions. They are based out of Columbus, Ohio and were founded in 1990.

    What kind of moat is there?

    Diamond Hill is primarily a legacy moat but they do have a small reinvestment moat. The legacy moat is built on a strong investment track record. They earn high marks from 3 rd party evaluators such as Morningstar and have built successful track records with their investment strategies that presents a barrier to entry for new competitors. According to FactSet, Diamond Hill has generated average returns on invested capital of 33% over the past 5 years. Diamond Hill is historically well-known for its approach to investing in US stocks but is reinvesting a part of that cash flow to seed new strategies in fixed income and international stock strategies that have been successful so far. Historically, about half of cash flow has been returned to investors through dividends and stock buybacks.

    How safe is this investment?

    As with any stock, there is plenty of risk. However, we believe the downside risk is less than the upside potential. As part of our financial analysis, we estimate how much a stock would be worth in different scenarios. In a scenario where Diamond Hill lost 10% of their customers every year which would pressure their profits, we believe the stock would still be worth $85. How can this be? All of the company’s shares are currently worth about $427M. The company has no debt outstanding and $225M in cash and liquid investments. If they closed up shop today, the cash and investments would be worth $70/share. We do not see this scenario as likely or we wouldn’t be buying it but it is important to try and understand the risks that you take in investing.

    Why is it trading for such a big discount?

    There are typically a variety of reasons a stock trades out of line with its intrinsic value. One answer is that small companies tend to get overlooked by analysts and the rest of the investment community. However, the biggest reason appears to be that Diamond Hill’s revenue been flat the past few years as more investors chase the high-flying growth stocks. Diamond Hill’s products are simply not popular at the moment, but these things run in cycles. We believe the market is overly pessimistic about the future of this company and expect that as the cycle runs its course their products will be popular again. We estimate that this does not need to happen for this to be a profitable investment, but returning the company to growth would likely lead to a very rewarding investment experience.

    In Summary

    At Aurora, we are constantly looking for attractive investment opportunities for our clients. We look for businesses with economic moats, quality balance sheets, and attractive upside potential. This blog represents our thinking at the time of publication. If you are a DIY investor, use this only as a starting point for your research and be sure to do your own due diligence. For questions regarding DHIL or our individual stock strategies, please reach out to us!

    Invest Curiously,

    Austin Crites, CFA

Austin Crites, CFA, stands before the Aurora Financial Strategies logo. The text is all caps in black with a blue ombre streak behind it. Austin is smiling in a blue button-down shirt and black glasses.


Austin Crites is the Chief Investment Officer of Aurora Financial Strategies, a financial advisory firm based out of Kokomo, IN. He can be reached via email at austin@auroramgt.com. Investment Advisory Services are offered through BCGM Wealth Management, LLC, a SEC registered investment adviser. This blog does not constitute advice. This is not an offer to buy or sell securities. Advisor is not licensed in all states. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. BCGM Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.  Clients may own positions in the securities discussed.

Source: https://www.aurorafinancialstrategies.com/blog/2020/10/9/why-we-bought-stock-in-diamond-hill-dhil

Austin Crites
Previous

The Most Important Phrase For an Investor: “I Don’t Know”
Next

THE ELECTION: ARE YOU WORRIED AS AN INVESTOR?