Shares of J.C. Penney (OTC:JCPN.Q) plunged below the $1 mark in the second half of July after the struggling retailer confirmed that it was investigating options for restructuring its debt. This development caused many investors to fear that bankruptcy was inevitable (if not imminent).

It substantially reduced its losses in the second quarter, though, despite another steep drop in sales. The company's margin expansion last quarter makes its problems seem far less dire. Moreover, several high-ranking executives and board members have bought substantial quantities of the stock with their own money in the weeks since the Q2 earnings report came out. This is a promising sign that J.C. Penney still has a reasonable chance of returning to profitability.

Revenue is still falling, but profitability improves

Comparable-store sales fell 9% last quarter. Excluding the impact of the company's moves to exit the appliance business and stop selling furniture in stores, comps fell 6%.

While this may seem like a fairly disastrous sales performance, new CEO Jill Soltau has made it clear that the status quo of using big markdowns to drive sales was not sustainable. Instead, she is willing to sacrifice some sales in the short term to improve profitability, while building the foundation for a return to growth by improving the retailer's merchandise selection and creating a more inviting shopping experience in its stores. The company has also implemented new policies and procedures to reduce the volume of "shrink" (lost and stolen merchandise).

The exterior of a JCPenney store

CEO Jill Soltau has focused on improving J.C. Penney's profit margin this year. Image source: J.C. Penney.

These moves began to pay off last quarter, as gross margin improved by more than 3 percentage points year over year. This enabled the company to cut its adjusted loss to $0.18 per share from $0.38 a year earlier. There's still more work to do to reach profitability, but the company's financial performance last quarter represented a step in the right direction.

A wave of insider buying

The day after the earnings report, Ronald Tysoe, Penney's board chairman, spent nearly $600,000 to buy 1 million shares of its stock, nearly quadrupling his holdings. This was a clear sign of his confidence that the turnaround is getting on track.

Last week, four more insiders made significant purchases of the stock. Soltau bought 500,000 shares, chief customer officer Shawn Gensch bought 250,000 shares, chief merchant Michelle Wlazlo bought 100,000 shares, and board member Javier Teruel purchased another 500,000 shares. All of these buys were made on the open market, meaning that these insiders are investing their own cash (as opposed to receiving stock as part of their compensation).

The five executives and board members who made open-market purchases over the past few weeks now own a combined total of approximately 14.7 million shares, nearly 5% of the company's share count. Soltau alone now owns 9.4 million shares, most of which she received as a bonus for joining the company last year.

How much weight should investors give to the insider purchases?

Whereas many retail pundits believe that it's only a matter of time before J.C. Penney goes bankrupt, insiders would have no reason to make open-market purchases if they thought that were true. The key question for ordinary investors is whether the recent wave of insider buying is a reliable signal that J.C. Penney is on the road to recovery, especially given that the company is still unprofitable.

Sometimes, insider buying is just a sign of overconfidence by executives. On the bright side, two of the insiders who made purchases last month are nonexecutive board members, who are less involved in day-to-day decision making and probably less likely to become overconfident. Furthermore, some research indicates that female leaders are less prone to overconfidence. Two of the three executives who bought the stock last week -- Soltau and Wlazlo -- are women.

So there is some evidence to suggest that the insider buying is a meaningful signal of better times ahead for the stock. That said, none of these executives and directors have spent life-changing amounts of money (relative to their earnings) on open-market purchases. J.C. Penney remains an extremely volatile stock with an uncertain future, making it suitable for only the most risk-tolerant investors.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.