In my experience, the DAC is where the magic happens. I used to have a Goldmund Mimesis which was a big heavy "mechanically grounded" CD transport and the Squeezebox's digital output easily unseated it with the dCS Delius/Elgar combo.
I think there are a couple of reasons for this. First, most high-end CD transports are designed to mitigate internal and external vibration--hence the heavy chasis and clamps, ect. With a Squeezebox type device, there are no moving parts to cause problems.
Further, when you rip a CD on computer, especially if you use error correction like in EAC, it is possible that the computer will make as many as 8 passes over the same section to error correct and account for imperfections, dust, scratches, ect. So what you end up with is a lossless file that is about perfect as it can get.
The main reason why the very best CD transports probably sound better than a Squeezebox type device, however has to do with build quality. High-end CD players are built with audiophile grade outputs, connectors and material and often include audiophile grade power supplies. There is meticulous attention to detail with respect to parts and components, ect. One mod actually separates the digital circuitry from the analog and interface circuity. This is the type of thing that isn't going to be built into a $300 Logitech device but would make it into a $4000 audiophile branded device.
This is why many people modify the Squeezebox with internal power supply and component upgrades and external third party power supplies. I have not tested this yet myself, however.
So really the problem is that we don't have a music server device that is up to the specs of some of the better end-game transports. Linn has one but I haven't heard it.
But the idea that streaming directly from the disc to the DAC is inherently superior has pretty much been debunked. The Boulder 1021 CD Player ($24,000?) for example brags about a ram buffer that buffers about 60 seconds of music in advance--it seems they have discovered not reading and processing in real time has some advantages.
The ideal device would be based on the Squeezebox but have the same build quality of an audiophile transport.