Did Mr. Market Overreact to David Tepper's Acquisition of J.C. Penney?

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If you want to get a general understanding of what's happening with a company's stock, you should try and see who owns a piece of it. The best way of doing this is by examining the 13F filings of reputable investment managers to see what they own. As required by law, any fund manager who is registered with the Securities and Exchange Commission (SEC) must report, on a quarterly basis, what their holdings consist of.

Utilizing this strategy, the Foolish investor would have stumbled upon the fact that David Tepper's Appaloosa Management, a $6.3 billion hedge fund, recently bought shares of J.C. Penney (NYSE: JCP  ) . Since inception, Appaloosa has earned an annualized return of approximately 30%, so it goes without saying that when he speaks, the market listens. This proved true yet again when, on last Friday, shares of J.C. Penney rose 3.9% on news of the investment.

The bad
For shareholders, this should be a cause to celebrate as it shows that one of the best-performing hedge fund managers of the past two decades believes that it could be a turnaround opportunity capable of yielding sufficiently high returns. But, is it possible that Mr. Market is overhyping the situation a bit, especially given the fact that Tepper only acquired $6.5 million (or 0.1% of his fund's worth) of stock?

Over the past few years, J.C. Penney has not been an ideal investment. From the company's 2012 fiscal year to its 2013 fiscal year, sales fell by 24.8% from $17.26 billion to $13 billion. Net income also fell precipitously, going from a gain of $572 million five years ago to -$985 million as of its most recent fiscal year.

Year-to-date, the picture has gotten progressively worse. In the company's second quarter of this year, revenue fell 11.9% from $3.02 billion to $2.66 billion. Meanwhile, its net loss widened as costs have risen relative to revenue, causing the company to report net income of -$586 million this quarter compared to -$147 million in the same quarter a year ago.

The good
On the flip side of things, there is some good news that has surfaced about J.C. Penney over the past couple months. In September, sales declined less than expected, while in October, the company saw sales rise by 1%. This represents the first sales increase since 2011. To make matters even better, its online sales rose an astonishing 37% compared to the same period a year ago.

With the thought in mind that J.C. Penney might be an attractive target, four other notable hedge funds bought, in aggregate, 8.1 million shares over the past quarter, while two other funds sold 7.43 million shares in aggregate. George Soros, who himself owns 19.98 million shares of the retailer, kept his holdings unchanged.

And the cautious
However, we should be mindful that just because an investor buys into shares of something, it does not mean that those shares are truly undervalued. Bill Ackman, a manager of a multi-billion dollar hedge fund, purchased around 40 million shares of J.C. Penney at approximately $25 (ouch!) and decided to sell off at a nearly $500 million loss this past quarter.

Another under performing investment by Ackman was Herbalife (NYSE: HLF  ) , a multilevel marketing firm that he alleges is set up as a pyramid scheme. After presenting his claim that the company is fraudulent, and admitting that his firm was short the company in the amount of $1 billion, investors like Carl Icahn and George Soros piled into the stock. This pushed the company's share price up 185% from its 52-week high and created a short squeeze that caused Ackman to restructure his investment and mitigate losses moving forward.

Foolish takeaway
Currently, shares of J.C. Penney are trading at about $9, which implies that they are monetarily cheap on a historical basis. However, the company is difficult to value because of its substantial drop in profitability. Naturally, this is bad for investors, but the rather big moves by big-name firms into the stock implies that there may be significant upside for anyone with the patience to wait everything out. This is, nevertheless, promising, but the important thing to focus on is the company's fundamentals, when it reports earnings this Wednesday.

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