<body.content> <block> <p>ITHACA, N.Y., Oct. 7 /PRNewswire/ — The Parker Center for Investment Research, an academic think tank and research institute housed at CornellUniversity’s Johnson Graduate School of Management, today said the Dow Index at 9,275.06 on Sept. 30 was undervalued using the 3-month Treasury bill yield (T-Bill) as the risk-free rate but fairlyvalued using the yield on 10-year Treasury bonds (T-bond).</p> <p>Because the 3-month T-bill has been accurate historically in predicting near-term Dow Index returns, a Parker Centerspokesperson said the Center concludes that the Dow Index is somewhat undervalued. (Charts available upon request show the intrinsic value of the Dow using both the 3-month T-Bill and 10-year T-bondrates.)</p> <p>”After reaching unsustainable highs in 1999 and 2000, the Dow Jones Industrial Average plummeted, reaching a bottom in 2002,” said Lakshmi Bhojraj, director of operationsat the Parker Center. “What this study tells us is that despite the Dow’s appreciation this year, it still has room to advance in the next six to twelve months.”</p> <p>The Parker Centeruses an innovative approach to valuing the Dow Index developed by faculty members, Professors Charles Lee and Bhaskaran Swaminathan. Their approach to calculating the intrinsic value of the Dowrepresents an attractive alternative to traditional market valuation techniques that have been found to have little predictive power, in part because they do not incorporate changes in risk-freeinterest rates over time.</p> <p>The Lee/Swaminathan method uses a bottom-up approach, in which each stock comprising the Dow Index is individually valued using a variation of thediscounted cash flow (DCF) approach known as the residual income model. This model incorporates time-varying discount interest rates and forward-looking earnings forecasts from sell-sideresearch.</p> <p>For further information on the Parker Center for assessing the intrinsic value of the Dow Index, see the paper, Valuing the Dow: A Bottom Up approach, on the ParkerCenter Web site: <a>http://parkercenter.johnson.cornell.edu/docs/working_papers/published/Valuing%</a> 20the%20Dow.pdf</p> <p>About the Parker Center</p> <p>TheParker Center for Investment Research is a fully equipped “trading room,” which uses $1.5 million of cutting-edge analyst software on an electronic educational platform, and is available to MBAstudents at Cornell’s Johnson Graduate School of Management. In addition, The Parker Center provides select second-year MBA students hands-on experience in the art and science of managing investormoney through the $2.4 million Cayuga MBA Fund hedge fund.</p> <p>Faculty members associated with the Parker Center specialize in research relevant to investment professionals. The ParkerCenter’s Web site — <a>http://parkercenter.johnson.cornell.edu/</a> — provides access to working and published papers on investment management as well as investment tools. The ParkerCenter was founded by Jeffrey P. Parker, MBA ’70, a founder and CEO of CCBN (<a>http://www.ccbn.com/</a> ), a web-based information services company, and the founder and managing directorof Private Equity Investments, a venture capital firm focusing on start-up and early stage companies.</p> <p>About the Johnson Graduate School of Management</p> <p>The JohnsonSchool is Cornell’s graduate school of management. Founded in 1946, and located at the center of one of the world’s top research institutions — the largest in the Ivy League, the school’s programsinclude MBA and doctoral degrees, an executive MBA, and a variety of non-degree executive education programs.</p> <p style=”pre” id=”pre1″> NOTE TO EDITORS: Two Attachments follow.
Table
Price/Value (P/V) ratios, means, and standard deviation
Using 3-Month T-bill and 10-year T-bond rates
Using T-bill as Using T-bond as
risk-free rate risk-free rate
P/V 0.62 1.25
Cumulative Historic Mean 1.13 1.41
Cumulative Standard Deviation 0.337 0.335
</p> <p>The table above shows the Price/Value (P/V) ratio of the Dow Index as of September 30, 2003, the cumulative historic mean of the ratio, and the standard deviation of the ratio relative to the historic mean, using both the 3-month T-bill and the 10-year T-bond rates as risk-free rates for valuation purposes.</p> <p>Lee and Swaminathan find that use of the 3-month T-bill rate yields more predictive results in the near term. The Dow is considered significantly over or undervalued relative to its historic mean if the P/V ratio is plus or minus 1.5 standard deviations away from the historic mean. In the table above, the P/V using the more predictive T-bill rate of 0.96% is 0.62, relative to its historic mean of 1.13. Because this result is almost 1.5 standard deviations away from the mean, the Dow is considered undervalued. Use of the T-bond rate, however, indicates that the Dow is fairly valued.</p> <p style=”pre” id=”pre2″> HISTORICAL CHARTS available upon request for comparative purposes.
A Brief Explanation of The Lee/Swaminathan method for Calculating the
Intrinsic value of the Dow Index.
</p> <p>Traditional aggregate market multiples (e.g., book to price, earnings to price) have little predictive power for overall market returns, in part due to their lack of a time-varying interest rate component. Applying a bottom-up approach corrects for this problem. Each stock comprising the Dow is individually valued using a discounted cash flow (DCF) model, and the results are aggregated to come up with the value of the Dow. This valuation model incorporates both time-varying discount rates and forward-looking earnings forecasts derived from sell-side research.</p> <p>Once the value of the Dow Index (V) is calculated, the Parker Center can evaluate the Price-to-Value ratio (P/V ratio) of the Dow at various points in time. Historically, the Dow has seemed significantly over or undervalued whenever the P/V ratio is more than 1.5 standard deviations above or below its historic mean. In their study, the authors show that P/V has statistically reliable power in predicting future market returns over the next 1, 3, 6, 9, 12, and 18 months. In other words, aggregate market returns tend to be higher (lower) in the months following relatively high (low) P/V ratios.</p> <p>Interestingly, the authors show that the choice of the risk-free interest rate of T-Bills and T-Bonds is crucial to estimating intrinsic value. They find that while the 10-year T-Bond is a more conceptually appropriate risk-free rate for valuation purposes, a P/V ratio based on the 3-month T-Bill has greater predictive power for future market movements. </p> <p>Center</p> <datasource>Johnson Graduate School of Management at Cornell University; Parker</datasource> </block> <block class=”contact”> <p>CONTACT: Michael G. Ettlemyer, +1-212-836-4224,<br/><virtloc idsrc=”dummy” value=”dummy”>[email protected]</virtloc>, or James L. Horton, +1-212-836-4212,<br/><virtloc idsrc=”dummy” value=”dummy”>[email protected]</virtloc>, both of Robert Marston Corporate Communications</p> </block> <block class=”website”> <p>Web Site: <a>http://parkercenter.johnson.cornell.edu/</a> </p> </block> </body.content>
