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 dont think buying the department store chains
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
Apples 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.