The Wisdom of the Value Crowd Can Be Wrong

NEW YORK (TheStreet) -- The value investing crowd is a fairly small, deep-knitted group, and when we latch onto a theme, or an idea, we usually don't let go of it quickly. Many of us attend the same conferences, pay heed to the same living value investing legends, and still espouse the investment philosophy of those that are no longer with us (such as Ben Graham).

There are times, however, when the wisdom of the crowd, even in value land, is just plain wrong. Certain names become the holy grail of deep value; the can't-miss opportunities. It's hard not to fall prey to this at times, and that applies not just to value investors.

A few years ago, Sears ( SHLD) was the name to own, primarily due to the leadership of Chairman Eddie Lampert, and the "hidden" value locked within the company's vast real estate portfolio. I saw all of the calculations generated by some big value players; what the company was said to be worth based on square footage of retail space, and it appeared impressive.

While I'm sometimes enamored with company-owned real estate assets, the Sears story never quite made sense to me, and I passed on it. Right or wrong, I could not escape the view that Sears was no longer the force in retailing that it was in my youth, and that perhaps the real estate was not as valuable as many believed. Assets may appear to have a great deal of value, but not so much if they can't be converted into cash. Shares that were trading above $120 in early 2010, can now be had for $43 and change.

The next big old-time retailing play was J.C. Penney ( JCP), and it was a similar story. In this case, new leadership by a legend, Ron Johnson, a former retail wiz at Apple ( AAPL), coupled with a formidable real estate portfolio. This was the next can't-miss opportunity, and investors bid shares up from $24 in August 2011, to about $43 in February.

Much of that gain was a "Ron Johnson premium"; based partly on his prowess, but also the fact that he put $50 million into 7.3 million 7.5-year J.C. Penney warrants which he had to hold for at least 6 years. The kicker was the strike price -- $29.92. If Johnson was willing to take such a risk, many believed, in which he could lose his $50 million if the stock did not perform, then he must be a believer.

So far, things have not worked out so well with Johnson at the helm, and with huge drops in same store sales, including down 27% in Q3, and surprisingly bad earnings numbers, shares are down 55% since peaking in early February. Some have been calling for the company to fire Johnson, and doubts that he can turn the company around from the old-style retailer it has been for many decades, are mounting.

Now, with many calling for the company's demise, I'm getting intrigued. Expectations have gone from very high, to extremely low. Perhaps this company can't be turned around -- that's how it's being priced -- or, maybe it will take longer to make the transition from old-style big box retailer, to the more hip, "100 shops" within one store feel that Johnson is shooting for.

The company ended Q3 with $532 million in cash and just under $3 billion in debt. While the debt concerns me, the company is loaded with tangible assets, namely the 400-plus owned locations. I won't make any bold assumptions of what the real estate might be worth.While it gives the company some options, clearly success for investors here is dependent on a turnaround in the retail business. If that does happen, the real estate may be worth more.

While it's easy to fall into a "value trap," as Sears has been to date, the nature of deep value is to consider buying when everyone else has given up. While J.C. Penney has some huge challenges ahead of it, for the first time, I am at least intrigued.

Not ready to pull the trigger, but intrigued.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Jonathan Heller, CFA, is president of KEJ Financial Advisors, his fee-only financial planning company. Jon spent 17 years at Bloomberg Financial Markets in various roles, from 1989 until 2005. He ran Bloomberg's Equity Fundamental Research Department from 1994 until 1998, when he assumed responsibility for Bloomberg's Equity Data Research Department. In 2001, he joined Bloomberg's Publishing group as senior markets editor and writer for Bloomberg Personal Finance Magazine, and an associate editor and contributor for Bloomberg Markets Magazine. In 2005, he joined SEI Investments as director of investment communications within SEI's Investment Management Unit.

Jon is also the founder of the Cheap Stocks Web site, a site dedicated to deep-value investing. He has an undergraduate degree from Grove City College and an MBA from Rider University, where he has also served on the adjunct faculty; he is also a CFA charter holder.

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