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In the third quarter of 2025, the financial markets experienced a continued ascent, building on the year's earlier gains. The Russell 3000 Index, a broad measure of U.S. equities, advanced by over 8%, pushing its year-to-date performance beyond 14%. This growth was notably propelled by the technology and communication services sectors, which saw increases of 13% and 12% respectively, largely influenced by a pervasive optimism surrounding artificial intelligence. Amidst this backdrop, characterized by robust market sentiment, Diamond Hill Capital Management maintained a steadfast commitment to its investment philosophy. The firm focused on diligently researching and uncovering high-quality companies whose market valuations did not fully reflect their intrinsic worth or long-term growth prospects. This strategic discipline is aimed at generating attractive returns for investors over the long haul, irrespective of prevailing market currents.

The third quarter’s market rally was broad-based, with small-cap stocks leading the charge, recording over 12% growth. Large and mid-cap stocks also saw positive returns, albeit at slightly lower rates. From a style perspective, growth stocks dominated the large-cap segment, while small-cap growth and value investments showed comparable performance. Geopolitical developments, trade negotiations, and monetary policy continued to be prominent concerns, yet the markets largely absorbed these factors, with several indices reaching unprecedented highs. The sustained enthusiasm for AI’s transformative potential fueled the technology sector’s robust performance, making it a significant driver of overall market returns.

Despite the overall market buoyancy, Diamond Hill's portfolio encountered relative underperformance compared to the Russell 1000 Value Index during Q3. This was primarily due to weaknesses within its financials and information technology holdings. Conversely, the firm's investments in materials proved to be a strong tailwind, boosting overall performance. Key positive contributors included Martin Marietta Materials and Sysco Corporation. Martin Marietta, a major supplier of heavy building materials, benefited from strategic portfolio optimization, including a divestiture aimed at enhancing its core operations, and was well-positioned to gain from an anticipated improvement in construction activity. Sysco, a food products distributor, showed promising sales growth, indicating success in its internal corporate initiatives. Other significant contributors included General Motors, Labcorp, and ConocoPhillips, each benefiting from industry-specific tailwinds and strategic operational improvements.

On the other hand, certain holdings weighed down the portfolio’s performance. Texas Instruments, a semiconductor manufacturer, experienced a decline in share price due to a slower-than-expected recovery in its industrial and automotive end markets. Despite this, Diamond Hill maintains conviction in the company’s strong competitive advantages, viewing these setbacks as temporary. Colgate-Palmolive, a consumer goods giant, faced pressure from broader consumer weakness and inventory adjustments by online retailers. High-quality defensive businesses like Colgate were observed to be out of favor during this period of market exuberance. Other notable detractors included American International Group, SBA Communications, and Salesforce, each navigating sector-specific challenges such as pricing pressures in insurance, slow 5G deployment, and conservative guidance from management.

During Q3, Diamond Hill Capital Management strategically adjusted its portfolio by initiating two new positions: Walt Disney and Zoetis. Walt Disney, a diversified media and entertainment conglomerate, was deemed attractive due to the strong growth potential of its streaming services and parks, anticipating these segments would offset weaker performance in its traditional television businesses. The company's valuation presented a compelling entry point. Zoetis, a leader in the animal health market, offered a robust product pipeline for both companion animals and livestock. Recent concerns regarding one of its arthritis medications for dogs had temporarily depressed its share price, creating an opportunity for investment below its estimated intrinsic value. To fund these new acquisitions, the firm divested its stakes in Pfizer, lululemon athletica, and SS&C Technologies, as these opportunities were considered less compelling at the time.

The prevailing macroeconomic environment presents a complex picture, particularly concerning consumer behavior. A widening divergence is observed between high-income earners, whose spending remains robust, and middle-to-lower-income households, which are increasingly impacted by job scarcity and inflationary pressures. This bifurcation poses a risk to future corporate earnings growth, especially given the significant role of consumer spending in GDP. Equity market valuations, having rebounded rapidly after a brief downturn, are now above historical averages, suggesting that future returns might not match past performance. Diamond Hill remains dedicated to active portfolio management, focusing on areas where market prices diverge from fundamental value to deliver superior returns to clients.

In an investment landscape heavily influenced by optimism around artificial intelligence, discerning investors face both challenges and unique opportunities. The current market's tendency to reward companies with even minimal AI exposure and disproportionately penalize those perceived as vulnerable to AI disruption or lacking sufficient AI integration creates a skewed valuation environment. While acknowledging AI's profound potential, Diamond Hill approaches such trends with caution, emphasizing that sentiment often outpaces reality. This methodical approach allows the firm to unearth high-quality companies with attractive business models that are currently overlooked or undervalued by a market too narrowly focused on a single theme. For patient investors, these conditions offer promising long-term return prospects, reinforcing the belief in a disciplined, fundamentals-driven strategy.