It can be done and that's a fact. The controls for the psp are pretty efficent even though it's just an hand held. If it can play games like this, http://www.youtube.com/watch?v=DTxNIuBA6Ag, it can play Diablo 2 no sweath. Why wouldn't you want to play Diablo 1 or 2 on an hand held? I would.
Those games look pretty. Then again that's what sony tries to do. Make shit look pretty.
Seriously though, all fun and sony bashing aside, there's more to a game then just the graphics, and with the AI, all the action of 8 players+monsters+bosses it can get a little bit heavy. And at that, an isometric action rpg would have some issues on a hand held with only a mini-joystick and four buttons+shoulder buttons.
Have you played Starcraft for the N64? The idea of controling even one character with an analog stick is rediculous. Of course you would have to make some changes, as the DS is built for fun, rather then a portable entertainment center for nerds ala PSP, but in the end it would be a better game, as it would offer much more controlability.
That being said, the PSP will still probably be choosen as the platform if there is a handheld version of Diablo released, and then when the game fails, and it will fail on a PSP, it will be given a fate similar to Diablo 1's expansion...
Edit:It was the PS1, not the PSP. And there is a reason why D2 isn't on the PS2 and D3 won't be on the PS3.