With shares up 140% since January, J.C. Penney (NYSE: JCP) is arguably the hottest story in the stock market this year. The company's stock has been on an upward tear since CEO Allen Questrom, a man who has been fixing defunct retailers for more than 30 years, came on board last September. Investors were given further evidence that the company is headed in the right direction when the department and drug store retailer reported some good news earlier this week.

J.C. Penney posted a second-quarter loss (before special items) of $45 million, or $0.20 per share, compared with a loss of $31 million, or $0.15 per share, in the year-ago quarter. Including non-comparable items, it lost $0.23 per share, versus a loss of $0.10 per share in the year-ago quarter. Sales were flat versus the same period last year at roughly $7.2 billion. Same-store sales gained 2.3% and 8.2%, respectively, at its J.C. Penney department stores and Eckerd drugstores.

While those figures don't look like much to get fired up about, consider the company's recent history: J.C. Penney's earnings plummeted from $2.54 per share in 1996 to a loss of $0.44 per share in 2000, while same-store sales (or "comps") at its department stores fell from 3.4% growth in 1996 to a 1.6% shrinkage in 2000. And while Eckerd has continued to post impressive comps growth, the chain reported a 2000 loss of $76 million.

Since Questrom's arrival, however, the company's results have started to improve and management has worked to increase the efficiency of operations by streamlining purchasing processes and enhancing store appearance and customer service. Many of those efforts, however, have yet to pay dividends, and J.C. Penney has opted to use promotions and markdowns to attract shoppers, forcing its department store and drugstore gross margins down from 34.1% to 33.2% and 22.8% to 22.6%, respectively, year-over-year.

Investors are now left wondering what's next, given the stock's runup and Wall Street's recognition of the turnaround. The stock has the potential to keep rising, but the road will get tougher with growing competition -- which has intensified as adverse economic conditions threaten to clamp consumer spending -- from the likes of Wal-Mart (NYSE: WMT), Target (NYSE: TGT), Walgreen (NYSE: WAG), and CVS (NYSE: CVS). Such threats, however, are by no means new to the department store and drugstore chain. (We've got more on this sector in our InDepth: Retail area.)

The turnaround, which is in the early innings of a long ballgame, will also get tougher as investors with increased expectations focus more on profitability. Same-store sales can increase at the expense of profits with discounts, but over the long haul the value of the company will be based on increased profitability and cash flow, accomplished by providing shoppers a compelling value proposition through improved merchandise and stores.

J.C. Penney has a team of executives in place with a track record for fixing ailing retailers -- Questrom led both Federated Department Stores (NYSE: FD) and Barneys New York back from bankruptcy -- so there's reason to think the company will prosper. But because shares have run up substantially over the last several months, there may be little margin for error for investors new to the stock.