Is Sears Holdings (NASDAQ:SHLD) an enigma to many investors?

On the surface, it's the combination of two big retailers, Sears and Kmart, that were struggling to compete with better-run discounters such as Target (NYSE:TGT) and Wal-Mart (NYSE:WMT), and with focused retailers such as Home Depot (NYSE:HD), Lowe's (NYSE:LOW), Kohl's (NASDAQ:KSS), and off-price retailer TJX (NYSE:TJX). I have no doubt that many investors looked at the Sears-Kmart merger, which closed in 2005, as a classic "1+1=1" merger, in which the two companies would continue their slide into irrelevance as they failed to generate value for shareholders.

Still, with around $54 billion in sales and about 3,800 stores, Sears Holdings is the third-largest retailer in the U.S. and controls the second-largest amount of retail square footage, behind only Wal-Mart.

I think the investment thesis for Sears Holdings has to begin by considering the options currently available rather than focusing on the massive strategic missteps of years past. This company is definitely being managed better these days, and with billionaire financier Eddie Lampert on board, it has more avenues available for value creation than the average retailer does. I don't believe that investors fully appreciate those avenues. In fact, the stock is being discounted heavily, because of the uncertainty surrounding whether the company's strategy will pay off.

Creating value in a non-linear fashion
Let's take a closer look at the approaches available to Sears Holdings.

1. A vehicle for Lampert's investment acumen. The hedge fund manager has compiled nearly 30% a year on average, after fees, since his fund was launched in 1988. David Geffen, the famed media mogul, invested $200 million with Lampert in 1992, and if Geffen had not repeatedly taken out funds for diversification purposes, the initial investment would be worth $9 billion -- a better performance than famed value investor Warren Buffett achieved over the same time frame. Of course, Buffett has a larger asset base impeding his returns.

In its most recent 10-K, under "related-party transactions," Sears Holdings spells out quite clearly how it intends to proceed with this approach in mind: "The Company's Board of Directors has delegated authority to direct investment of the Company's surplus cash to Edward S. Lampert subject to various limitations that have been or may be from time to time adopted by the Board of Directors and/or the Finance Committee of the Board of Directors."

Lampert has quite a bit of moola to work with; Sears Holdings' cash pile is currently at $3.7 billion (including Sears Canada), and the company generated $1.8 billion in free cash flow last year -- far above what the company requires for its operations. If Lampert's record is any indication, those results should be positive for the company. But much like Lampert's hedge fund investors, who are subject to a five-year lockup (the industry standard, in comparison, is one year) and have absolutely no disclosure about what the fund is investing in, shareholders will simply have to trust Lampert to perform.

2. A retailing turnaround. Lampert has hired Aylwin Lewis, a relative newcomer to the retailing industry who previously was president of Yum! Brands after leading turnarounds at KFC and Pizza Hut, to serve as Sears Holdings' CEO. The two men are focused on remaking the company into a "learning organization" in which experimentation is encouraged and employees are honored by being recognized for their financial literacy.

3. An opportunistic real estate liquidation/rationalization. Lampert has already taken this route once, with the sale of 68 Kmart stores to Sears and Home Depot in 2004 for more than $846 million. Deutsche Bank and Morgan Stanley estimate the real estate value on Sears Holdings' books to be anywhere from $21 billion to $38 billion, thanks to Sears' acquisition of many prime locations in the 1960s and 1970s. The company's book value is $11 billion, which means that any gains would be taxed at an estimated 35% tax rate. Using the lowest number to be conservative -- $21 billion -- results in a tax liability of $3.85 billion and a net value of $17.15 billion, or roughly 75% of the current enterprise valuation of the company. That provides a floor for the share price.

In Eddie we trust?
Lampert is a key figure in Sears Holdings' future success. He engineered the Sears-Kmart merger after acquiring 54% of Kmart in its bankruptcy and now owns a 41% stake in the combined company. Aside from his hedge fund accomplishments, which he achieved partially by acquiring large stakes in AutoZone and AutoNation and then agitating for change -- similar to what he is doing with Sears now -- he can also credit his admiration of Buffett for some of his success. Lampert started studying Buffett shortly after graduating with a degree in economics from Yale, where he studied some reverse-engineering deals that Buffett undertook. Lampert would go back over the previous annual reports for Buffett's acquired companies and try to understand why the Oracle made those deals. He eventually met Buffett in 1989 for a 90-minute interview.

As a result of getting to know Buffett and his approach, Lampert hates to waste money and always seeks to invest every dollar at the highest return possible. Lampert put that philosophy into action at Sears Holdings, which cut capital expenditures by 50% to $546 million in 2005 and has bought back nearly $600 million in stock in the past year. Also in Buffett-like fashion, Lampert's recent chairman's letter makes clear that his goal is to increase the per-share value of Sears Holdings, by improving the company's operations to make it a great company and by buying back stock to magnify the effect thereof.

Lampert also rails against overfocusing on same-store sales. He argues that companies that place too much emphasis on increasing this metric may not be allocating capital most effectively. (Our own Alyce Lomax penned an excellent article highlighting some other trends with same-store sales.) Lampert also emphasizes that companies should consider the cost of generating profit -- $1 million in annual profits achieved by investing $5 million is quite a different return from investing $20 million for the same $1 million profit. It is this type of owner mentality that drives him to obtain the highest possible return for shareholders' cash -- and, no doubt, his 41% stake in the company helps.

What about Sears and Kmart?
Aside from Lampert's investing skills, a large part of the future return for shareholders has to come from what some observers call the impossible task of turning the retail giants around. Still, once again, Lampert and CEO Lewis have a plan to build long-term customer relationships with the best people available. After a nearly complete gutting of top management, Lewis is inviting 500 top managers, 40 at a time, to attend a daylong course called "Sowing the Seeds of Our Culture." Employees are being asked to "drink the Kool-Aid" and make a choice: Buy into a new culture of risk-taking, testing, and making money, or leave.

Lampert manages from 50,000 feet and provides strategic direction, and he is the company's No. 1 user of an online tool that allows managers to dissect the company in granular detail by store, region, and merchandise group. Lewis, on the other hand, manages at the ground level, working closely with top management and visiting stores to gather feedback.

Will all of this work out for shareholders? I'd say the risk/reward is quite good, given that the stock is really pricing in minimal contributions from the turnaround and Lampert's as-yet unknown investment returns. Consider that Sears may be priced at "trough" earnings with a 20 P/E and a 0.4 price-to-sales ratio. But as the turnaround takes place, those numbers could fall considerably. While the company is more expensive than Wal-Mart and Target, which both trade at a P/E ratio of nearly 18 with far better returns on equity, Sears may be more rewarding to the contrarian investor who is willing to invest where much uncertainty looms.

The company's willingness to admit failure with the recent Sears Essentials concept, now renamed Sears Grand, and its readiness to introduce Sears products into the Kmart retail environment represent bold retailing moves that indicate outside-the-box thinking. I think shareholders who consider Sears Holdings shares at current levels will also be well rewarded for their own ability to think outside the box.

For more Foolishness on retailing and Sears Holdings, check out:

Wal-Mart, Home Depot, and AutoZone are all Inside Value recommendations. Interested in other potential bargains? Take a free trial to see where lead analyst Philip Durell is finding them today.

Fool contributor Stephen Ellis does not own shares in any companies mentioned. You can see his holdings for yourself . The Motley Fool has a disclosure policy.

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.