(DHIL) - Diamond Hill Investment Group is a diamond in the rough with special properties that Norton and Gillespie's readers should find attractive

Charles Norton and Allen Gillespie, editors of the Supernova Stocks newsletter, update investors on recent market action, draw parallels between past market events versus today's state of affairs and profile a diamond company. Benefit from these experts' explanation of what is happening with the current economic situation. Then read their analysis of a stock that is shining brightly. Commentary from September 1 Since Charles Norton and Allen Gillespie's last newsletter, the market has been attempting to claw its way back up to the scene of its May breakdown. While the S&P 500 has been somewhat successful in that endeavor, small-cap, technology and higher growth stocks have continued to struggle. The market scored a follow through day but investors should not throw caution to the wind. The follow through day was a very belated signal and leadership is still lacking. Prior leadership continues to break down, while the new leadership is clearly in the large-cap consistent earnings sectors like supermarkets, pharmaceuticals and consumer goods. In short, the market is clearly sending a message that it is preparing for recession. There are a couple of investment precedents Norton and Gillespie would like to make their readers aware of. There is a history of market breaks following the appointment of new Fed chairmen. In 1979, after Paul Volcker took the reins, the market broke then rallied back to a new high before a more severe setback of 200 points on the Dow, which was trading at 920 at the time. Shortly after Alan Greenspan became chairman, the 1987 Crash occurred. Norton and Gillespie see another interesting parallel between this market and the 1993 market, which struggled with inflation concerns following Hurricane Andrew (1992), the largest hurricane in terms of damage until Katrina. The S&P 500 was able to finish 1993 up just over 7% but then entered 1994 with a thud as it fell from just over 480 to less than 440. Stay tuned as Norton and Gillespie continue to monitor this parallel throughout the year. Shining Brightly Diamond Hill Investment Group (DHIL) is a diamond in the rough with special properties that Norton and Gillespie's readers should find attractive. The Fundamentals & Valuation Diamond Hill has been printing some serious green for a while now with eight straight quarters of triple digit sales growth and six of those showing triple digit earnings growth. The company is quickly ballooning its assets under management (AUM), a key metric in the analysis of financial services firms. Management has stated that important economies of scale will be achieved when assets reach the $2 to $4 billion range. It accomplished this goal in the June 30 reporting period with $2.7 billion in AUM. Investment management firms are highly scalable. They typically have a low employee count relative to revenues. Because retaining key employees is critical, they tend to be highly compensated. Diamond Hill reports just 21 employees, up from 13 a few years ago. Compensation jumped significantly from $2.2 million to $6.8 million in a year. This works out to $325,000 per employee. The increase was driven by performance bonuses. While the company states that the pay was for the performance over the last five years, it is still a significant jump. Such a large change makes it more difficult to project future earnings per share. With thinly traded companies, one is always concerned about them being run as quasi-private concerns rather than public companies. Diamond Hill has stated it is aiming to achieve 30% margins and the partnership did kick in a performance fee of $2.4 million for the year. The five year turnaround has been dramatic but going forward Norton and Gillespie believe employee compensation is a critical variable to monitor. Investment management firms have low fixed asset requirements, and again, Diamond Hill is no exception to this rule. As of June 30, the company had $19 million in assets, all of which are very liquid with $4.9 million in cash and near cash assets, and $13 million invested in the company's various funds. Importantly, of the $13 million invested, a little over $10 million is in the two private partnerships. This demonstrates Diamond Hill's confidence in their long-short strategies. The liabilities were $5.6 million giving the company a tangible book value of around $14 million dollars. Estimating a fair price for such a new company is challenging. On a book value basis, the stock certainly does not look cheap. Revenue growth has been outstanding, but the company has closed its most successful fund to new investors. A general rule of thumb for the investment management industry is to pay 4 times revenue. Based on the latest quarter, this would argue for a market cap of $85 million, or $48 per share. However, given the potential for performance fees related to the hedge funds, one might consider paying a slightly higher price. The danger to an outside shareholder is that the performance fees fail to flow through to the bottom line because they are paid out as incentive compensation. Summary Diamond Hill Investment Group's commitment to the alternative investment space makes it an exciting way to participate in the growth of the hedge fund industry. Investors benefit because the balance sheet is heavily invested in its funds, and also benefit as assets under management grow. More importantly, because it is a public company, investors do not have to worry about transparency issues. Content Courtesy: Zacks Investment Research | Blog Home| VitalStocks Home