Click on any step in the process for more detailed information.
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Our research is predominantly a bottom-up process beginning with fundamental analysis of a company's profitability and
market position, financial and competitive position, management quality, valuation, and growth components of valuation. Top-down analysis is focused on industry dynamics, including sector economic factors, long-term capital flows, and the regulatory environment, not on macro-economic factors. Investment team insight and experience is then applied to further narrow the universe of investable ideas for deeper analysis including the creation of a financial model. The initial pool of stocks available for investment ideas is based on the market cap range for each strategy.
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Using our proprietary Diamond Hill Investment Model (DHIM), we estimate the intrinsic value for each potential holding,
which is independent of its current stock price. This price may be higher or lower than intrinsic value at any point in time. The process begins with consensus estimates for company data, and then the initial appraisal is modified based on further refinement by our research analysts. Our investment process continually compares market price to our estimate of intrinsic value, which is updated over time as new information arises. For our long positions, we not only search for stocks trading at a discount to intrinsic value, but also stocks whose intrinsic value we believe will grow over time, thus adding to the upside potential during the holding period. For short positions, a growing intrinsic value would be a detriment to the performance of the holding.
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A sufficient "margin of safety" is provided by mispricing opportunities in the market. Having identified this margin of safety, a portfolio manager will buy long (or sell short) a position, with the position size dependent upon the confidence level in our estimate of intrinsic value. Other potential positions/ideas are followed and purchased (or sold short) if they become attractive over time.
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Portfolios are constructed in alignment with the strategy's model portfolio, then monitored and rebalanced according to established risk control guidelines, including maximum position size at market and at cost, industry/sector exposure, and market cap limits based on strategy. Positions are monitored through ongoing research, and the relationship of stock price to estimated intrinsic value is watched closely as market conditions change. The appropriate actions regarding holdings are taken, as necessary.
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Positions are sold when the market price appreciates (or covered when the price declines) and/or the position appreciates to more than 7% of the portfolio (10% in our private investment funds). We will also close a position if the "margin of safety" erodes due to a deterioration (or improvement) in fundamentals. Finally, we may find a more attractive opportunity, in which case we would sell an existing position (or cover) to raise proceeds for a new position.
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Throughout the process, we challenge ourselves by identifying instances when the execution of our investment process
was flawed. We examine all steps in our process and ask questions regarding failure to include relevant information in our analyses, errors in the calculation of intrinsic value, effectiveness of the trading process, effectiveness in trimming or adding to positions, and diligence in updating intrinsic value estimates. The goal of this step is to identify issues and inefficiencies in execution, with the result being enhanced execution.
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Above is a graphical representation of relative risk vs. potential yield for various income producing investment alternatives. |
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