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Caution! Avoid J.C. Penney stock

May 13, 2014: 12:39 PM ET
Customers may be coming back to J.C. Penney. But investors need to be careful. The stock has enjoyed a huge bounce.

Customers may be coming back to J.C. Penney. But investors need to be careful. The stock has enjoyed a huge bounce.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.

"When it fits, you feel it," is the strange (and slightly dirty) new slogan for J.C. Penney.

But is the struggling retailer's stock finally a good fit for your portfolio? Shares certainly are feeling the love from Wall Street lately. They've nearly doubled from their 52-week low!

So far in 2014, J.C. Penney (JCP) stock is up a bit, so it's done better than many of its competitors. Shares of Kohl's (KSS) and Target (TGT) are in the red year-to-date. So is the broader S&P Retail ETF (XRT). Wal-Mart's (WMT) stock is flat. Raise your hand if you thought J.C. Penney would be a leader in its sector this year. Anyone? Anyone?

Is this rebound for real? We all know how Americans love an underdog. And J.C. Penney is undoubtedly the David of retail.  In case you haven't followed the company's troubles over the past few years, here's the CliffsNotes version.  I suggest you sing it to the tune of Billy Joel's "We Didn't Start the Fire."

Mounting losses. Awful sales. Ackman buys stake. Myron Ullman bails. Ron Johnson to save day. Free haircuts. Where's St. John's Bay? No coupons. New logo. Stock's still a no go. Customers mad. Johnson canned. Ackman gone. Ullman back again. Market cap blown away. What else do I have to say?

So what's next for J.C. Penney? The company will report its first-quarter results on Thursday. It looks like it will be a mixed bag. Analysts are predicting a small increase in sales. That's a good sign. But the retailer is expected to bleed even more red ink.

Related: Is J.C. Penney an 'American comeback story?'

With that in mind, the stock may not have much room to climb further unless J.C. Penney wows investors with a much bigger gain in sales (especially same-store sales) and a narrower loss. If Ullman shows investors that progress is being made in turning the company around, investors may remain in a forgiving mood.

There's a chance that the first quarter sales numbers could surprise the market in a good way. J.C. Penney does have the benefit of great timing. The company announced last October that it was launching a Disney (DIS) shop in more than 500 of its stores.

The amusing thing (in hindsight) about the press release was that J.C. Penney touted "beloved characters" from Disney's "Monsters University," "Toy Story" and "Tangled" as examples of merchandise that could be found in the stores. There was no mention of a certain animated film that Disney was releasing the next month: "Frozen."

And as everyone now knows, "Frozen" could turn out to be one of the biggest success stories in Disney's history. So J.C. Penney may actually be able to report a good quarter "for the first time in forever" thanks to strong sales of Elsa, Anna, Olaf and Sven products.

But will "Frozen" largesse be enough to thaw the hearts of some still skeptical J.C. Penney bears? I'm not sure.

The market's patience with retail turnaround stories is notoriously thin. Just look at JCP stock under Johnson. It had done extremely well for awhile in 2011 due to hopes that he could make J.C. Penney like the Apple (AAPL) Stores he used to run. But once it became clear that his strategy was not working, the bottom fell out of the stock.

Even with the recent spike higher, J.C. Penney shares are well below the levels they traded at just a few years ago.

Best Buy (BBY) is another example of how a poorly performing retail company is given some benefit of the doubt for a little awhile. The stock was the second-best performer in the S&P 500 last year as investors bet that new CEO Hubert Joly would make the electronics retailer more competitive against the likes of Amazon (AMZN) and Wal-Mart.

But Best Buy went from 2013 stud to 2014 dud. The company has hit a speed bump on the road to recovery and shares are down more than 33% this year.

Could the momentum suddenly shift with J.C. Penney as it did with Best Buy? Yes.

There are two things that make me nervous about the big run-up in J.C. Penney's shares over the past few months.

The stock is now approaching its book value of about $10.13 a share. Given that J.C. Penney is still not a healthy company and there continues to be speculation about whether the retailer may have to close more stores or worse, should the stock trade for much more than it is theoretically worth in a liquidation? I'm not sure about that.

Sure, J.C. Penney may have been drastically oversold when it was trading below $5. And there may be some hidden value in its real estate. But buying a poorly performing stock because you think it might be a REIT wolf in retail sheep's clothing is risky. Leave that gamble to Eddie Lampert and Sears (SHLD).

If J.C. Penney is going to really get back on the long-term path to success, it will need to get more customers in the stores, not sell real estate.

Related: Inside the "cleanse" at J.C. Penney

But the bigger worry is that the "rally" in J.C. Penney may be a mirage. It could be, in a twisted way, a byproduct of all the bearish bets against it. Let me explain.

Nearly a third of J.C. Penney's available shares are being held by short sellers, investors who try to profit from a stock losing value by borrowing shares and selling them with the hopes of eventually buying them back later at a lower price.

When a stock that's heavily shorted starts to climb, the short sellers are often forced to buy back shares sooner they might like to cover their position and avoid huge losses. That's a phenomenon known as a short squeeze. And that may be what's going on here.

So if J.C. Penney's sales don't live up to expectations Thursday, you could wind up with another fresh wave of shorts coming in to dump the stock.

Time will tell if Ullman can fix J.C. Penney and return the company to the iconic status in retailing that it once had. But for now, the comeback story doesn't fit with me. I'm not feeling it.

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Paul Lamonica
Paul R. La Monica
Assistant Managing Editor, CNNMoney

Paul R. La Monica is an assistant managing editor at CNNMoney. He is the author of the site's daily column, The Buzz, and also tweets throughout the day about the markets and economy @LaMonicaBuzz. La Monica also oversees the site's economic, markets and technology coverage.

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