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What I Learned from the J.C. Penney Fiasco

In December 2012, I sang praises to J.C. Penney Co.’s stock. This summer my firm sold it at a loss. In this article I would like to put salt in the open wound and talk about what I learned from the J.C. Penney fiasco.

I don’t think buying the department store chain’s shares was a mistake. Investing is a probabilistic adventure: You assess upside and downside probabilities of a potential investment, and if at the end the balance is significantly favorable, you pull the trigger.

Uncertainty is the nature of investing. Let me illustrate. Suppose you were offered a coin-flip game: Heads you win $10, and tails you lose $1. It makes complete sense to play this game; the expected return (probability times outcome) is overwhelmingly in your favor. So if you flip the coin and get tails, was playing the game a mistake? No, of course not.

In the case of J.C. Penney, the story was fairly straightforward. The company had been neglected and undermanaged. Old management was fired, and brilliant new management was brought in. New management developed a plan for completely redesigning the stores, giving them a real face-lift, upgrading merchandise and turning J.C. Penney into one of the best-looking stores in the mall.

The new CEO, Ron Johnson, had been instrumental in creating Apple’s stores and was a very well-respected retailer. At the time Johnson was executing on his plan — remodeling stores as J.C. Penney continued to bleed money — this is what I wrote: “The best thing about Penney is that the bar for success is set very low. Since he took over, Johnson has taken out $900 million in costs. Sales per square foot should rise with every redesigned store. If Penney achieves the pre-Johnson level of $150 per square foot and gets to keep $700 million of cost cuts, its earnings power will be $3 to $4 per share. If sales per square foot come back to the 2007 peak of $170, earnings will jump to $6 a share.”

We thought there was a very high likelihood — 70 percent or so — that Johnson would be successful; if so, the upside would be threefold or more. If he failed — a 30 percent chance — the downside was probably 40 percent or so. The risk-reward scenario was very attractive.

Leave a Comment    (5)

  • POST

The investment in JCP was emblematic of the risks associated with buying the "paper" company. I don't think anyone who actually shopped at malls where JCP resides would have given the chance of success of any CEO even a 50-50 shot. I'd love to know whether any focus groups were polled about JCP - and if so, who was on those polls. Those who shopped only at Short Hills, or 5th Avenue wouldn't have had a clue.

Nov 14 2013 at 4:47 PM EST

Deborah Gatzek

Fine post. Would like to have more of the methodoligy
aound position size though.


Nov 11 2013 at 1:37 PM EST

sam from

Excellent read and thanks.

Here's one flaw: JCP isn't capable of everyday low prices. The key word is low. They have a higher cost structure than others. When you can't be a leader on price, style, quality, etc then you need price discrimination strategies.

Nov 11 2013 at 1:10 PM EST


the tricky thing for investors/traders is in accurately assessing the accuracy of their probability estimates...

I tried to explain what I mean by this in this post:

in other words, you judged JCP to be a 70% chance of a triple and a 30% chance of a 40% loss... obviously, as you explained, just because you ended up with the "loss" outcome doesn't mean you made the wrong decision, but the problem is that we also have no idea if your 70/30 assessment was accurate... this is the hard part...


Nov 11 2013 at 1:09 PM EST

Kid Dynamite

Interesting... Mathematically one can make the case that, all else being equal, size should be proportional to edge (expected % gain) / risk (gain on success/loss on failure) . The sizing factors discussed seem indirectly related to the range of potential investment outcomes. There is also the matter of correlation to the rest of the portfolio. Of course, this assumes those can be determined a priori... Better to have a methodology than no methodology, but risk is inherently subjective, a methodology simply restates the problem so you have estimate inputs subjectively, instead of estimating a proper size subjectively.

Nov 11 2013 at 11:11 AM EST

Druce Vertes