C&B Notes

A Case Study in Market Inefficiency

One of our favorite quotes from Ben Graham: “In the short run, the market is a voting machine, but in the long run it is a weighing machine.”  A short-term disconnect between stock price and business value is what gives us, as value investors, the opportunity to buy cheaply and sell dearly.   Although the summary of the efficient market hypothesis is a little oversimplified at the beginning of this article, we appreciate this example of the market appearing to “vote” instead of “weigh”:

In October 2010, Bill Ackman of Pershing Square filed a 13D with the SEC indicating that his firm had taken a 16.8% stake in Penney’s, causing the stock to move up nearly 5% and to a price nearly 60% higher than where it had traded just a month earlier.  After that time, the stock was relatively range bound, and traded at a price between $30 and $40 per share until mid-2011.

On June 14th, the retail world was enamored with the announcement of former Apple (AAPL) retail head Ron Johnson as Penney’s new CEO, with the stock shooting up nearly 20% in the trading session.  Yet for some reason (there was no material news announced), the obsession with Mr. Johnson faded and the fear of a euro crisis continued to circle the market (where Penney’s doesn’t have a single store), resulting in a share price decline of one-third in the next sixty days.

As Mr. Johnson began building a management team with former Target co-workers (namely Michael Francis) and speculation began to swirl about his transformation plans, the market got interested in JCP again, with the stock working its way back to $35 by late January.

On the 25th of that month, JCP’s management team hosted an event to outline the company’s transformation plans; looking at how the stock reacted, you would of thought that Mr. Johnson announced that Penney’s had attained exclusive rights to distribute Apple products — the stock shot up nearly 20% again, the second time in less than six months that a press release had caused the company to add more than $1 billion in “value”.

The stock peaked around $43 over the next two weeks, and has been on the decline ever since; today, it sits at a shade under $35, nearly identical to the price that the stock had hit upon the announcement of Mr. Johnson’s hiring.  In the past ten months, very little has changed at J.C. Penney’s; the company is in the early stages of a transformation that will take years to complete.

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