There are few things more satisfying for an investor than finding a beaten-down stock that the market is simply wrong about. When the market comes to see the error of its ways, the reward is both monetarily and intellectually gratifying. This is the very essence of a value stock.
While investing in value stocks can be highly lucrative, it can also lead to massive losses. One of its main perils is what's known as a value trap. This is a stock that, as the Fool's wiki page puts it, "masquerades as a value stock because its stock price has been beaten down. However, unlike a true value stock, a value trap's price is low for a good reason."
At any one time, there are numerous value traps littering the marketplace. The key is to identify them as such before they make their way into your portfolio. How do you do this? You look beyond stock price to the fundamentals.
With this in mind, I've culled the retail sector to identify its biggest value trap. Suffice it to say, unless you're a short-term speculator looking for a quick turnaround, I'd highly recommend avoiding this stock altogether.
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The market rejoiced last June when it was announced that Ron Johnson, the former head of Apple's retail division, had agreed to take the reins at J.C. Penney (NYSE: JCP ) . Working in close collaboration with the late Steve Jobs at Apple, Johnson had engineered one of the most successful retail stories of our age. There was accordingly good precedent to believe he could do the same at J.C Penney.
With over a year at the helm, however, things aren't looking quite as good. Under Johnson, the company has abandoned its bread-and-butter focus on promotions and limited promotional events -- what one retail-focused stock website terms "the essence of middle America" -- in favor of an everyday-low-price strategy made famous by Wal-Mart (NYSE: WMT ) .
It's also invested heavily in reformatting its stores into boutique-like amalgamations. In the first quarter of this year alone, for example, the company spent more on capital improvements than it had in all four quarters in each of 2010 and 2011.
To say that this strategy has yet to pan out would be an egregious understatement. In the first quarter of 2012, same-store sales at locations open at least a year were down a staggering 18.9%. And lest you think it couldn't get any worse, they were down 21.7% in the second quarter. Declines like this are virtually unprecedented.
Johnson is nevertheless sticking to his guns, announcing in the company's second-quarter earnings release: "We have now completed the first six months of our transformation, and while business continues to be softer than anticipated, we are confident the transformation of J.C. Penney is on track. The transition from a highly promotional business model to one based on everyday value will take time, and we will stay the course."
Although it's tempting to argue that these declines are also attributable to the overall economy, this simply doesn't stand up against the numbers. In the second quarter of this year, for example, domestic comparable-store sales at Wal-Mart and Target (NYSE: TGT ) were up 2.2% and 3.1%, respectively. Even Sears Holdings (Nasdaq: SHLD ) , which appears to be self-liquidating, saw its domestic comps erode by only 2.9%.
Do yourself a favor: Avoid this stock
While it's impossible to predict the endgame for J.C. Penney, one thing's for certain: The odds aren't in its favor. It's for this reason, in turn, that I'd encourage investors to steer clear of this textbook value trap. In its place, a much more promising stock is the one our analysts have selected as The Motley Fool's top stock for 2012. To learn the identity of this stock, download our free report.
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