General Machine Works Inc. (GMW) has been losing money for some time but has managed to maintain an annual dividend of $1.. The company’s strategy is to restructure by getting smaller while working on labor and product line problems at the same time. Once that’s done management feels the firm will return to profitability and begin a long period of growth at about 3% per year. GMW’s stock price has been declining steadily for some time and is now the neighborhood of $20 per share.
You’re an analyst for Barnstead and Heath, a small brokerage firm that employs a number of financial consultants who advise clients on stock investments. Some of the consultants feel that GMW’s strategy will work as planned and have asked you if they should tell their clients that this is a good time to buy GMW stock. How would you advise them? Assume clients demand a return of about 10% and that dividends will shrink by 10% per year for 3 years.