Dow Index Average Fairly Valued

Three Stocks Overpriced
International Paper, DuPont and Wal-Mart Are Too Expensive Says Cornell Johnson School Analysis

February 10, 2004, Ithaca, New York The Dow Jones Industrial Average, which tracked sideways through January, remains fairly valued, according to proprietary analysis performed monthly by the Parker Center for Investment Research, an academic think tank and research institute housed at Cornell University's Johnson Graduate School of Management. The Center has also identified three stocks in the Dow 30 average that it considers overvalued - International Paper, DuPont and Wal-Mart.

"Our quantitative models and fundamental analysis found the Dow average to be fairly valued. Of the component companies, we believe International Paper is overvalued and DuPont and Wal-Mart are also somewhat overpriced," said Lakshmi Bhojraj, director of operations at the Parker Center. The Dow closed at 10,488.07 on Jan. 30, up 34.15 from 10,453.92 on Dec. 30.

The Parker Center index was developed by two faculty members, Professors Charles Lee and Bhaskaran Swaminathan. Their approach to calculating the intrinsic value of the Dow represents 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-free interest rates over time.

The Lee/Swaminathan method uses a bottom-up approach, in which each stock comprising the Dow Jones Industrial Average is individually valued using a variation of the discounted 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-side research.

For further information on the Parker Center for assessing the intrinsic value of the Dow Jones Industrial Average, see the paper, "Valuing the Dow: A Bottom Up Approach" on the Parker Center Web site.

About the Parker Center
The Parker 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 MBA students 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 investor money through the $2.9 million Cayuga MBA hedge fund.

Faculty members associated with the Parker Center specialize in research relevant to investment professionals. The Parker Center's Web site -- http://parkercenter.johnson.cornell.edu -- provides access to working and published papers on investment management as well as investment tools. The Parker Center was funded primarily by Jeffrey P. Parker, MBA '70, a founder and CEO of CCBN (http://www.ccbn.com), a web-based information services company, and the founder and managing director of Private Equity Investments, a venture capital firm focusing on start-up and early stage companies.

About the Johnson Graduate School of Management
The Johnson School 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 programs include MBA and doctoral degrees, an executive MBA and a variety of non-degree executive education programs.

Note to editors: historical charts are available upon request for comparative purposes.

Price/Value (P/V) ratios, means, and standard deviation
Using 3-Month T-Bill and 10-year T-Bond rates

The table above shows the Price/Value (P/V) ratio of the Dow Index as of Jan. 30, 2004, 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.

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.

A Brief Explanation of the Lee/Swaminathan Method for Calculating the Intrinsic Value of the Dow Index
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.

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.

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.

For More Information
Randall Sawyer
Public Relations Officer
607 255-8006
rs348@cornell.edu