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Kohl’s Corporation (KSS): Take Advantage of Short-Term Volatility and Buy This Long-Term Value

Kohl’s Corp. call options active as shares sell offWhile traders abhor volatility, long-term investors profit from it. Value investors like Warren Buffett take advantage of unwarranted downside volatility that unfairly punishes great businesses. Value investing is often described as value arbitrage — as in, value investors arbitrage the difference between price and value — but it is sometimes better thought of as time arbitrage — that is, buying the long-term view and ignoring the short-term outlook.

In no industry is time arbitrage a more profitable strategy than in consumer retail. Short-term traders tend to give heavy weight to quarterly same-store sales figures and similar measures that rarely provide any insight into the long-run prospects of the retailer. This provides many excellent opportunities for long-term investors to scoop up bargains after a quarterly miss.

A decent prospect

Although it is a few quarters removed from its most recent disappointment, Kohl’s Corporation (NYSE:KSS) remains in the bargain bin due to short-term fears despite a healthy long-term outlook.

The company reported slower-than-expected same-store-sales growth last November, which spooked the market into a large sell-off. Although the stock price has retraced its losses, the company remains undervalued.

For one, Kohl’s Corporation (NYSE:KSS) increased offering of private label products has enabled the firm to increase its margins significantly. In fact, its gross margins and pre-tax margins are higher than those of Target Corporation (NYSE:TGT) and J.C. Penney Company, Inc. (NYSE:JCP).

That Kohl’s Corporation (NYSE:KSS) consistently earns a higher operating margin than both Target Corporation (NYSE:TGT) and J.C. Penney is no small feat. Target is a significantly larger company with superior economies of scale. Meanwhile, J.C. Penney Company, Inc. (NYSE:JCP) has traditionally sold higher-margin products than Kohl’s. Despite the lack of a clear advantage in any one area, Kohl’s Corporation (NYSE:KSS) responsible growth strategy enables it to out-earn its toughest rivals.

Thankfully, J.C. Penney is much less of a competitive threat today than it was before Ron Johnson attempted to transform the company. As a result of the failed transformation, J.C. Penney is scrambling to return to its old strategy — the one that led to the precipitous drop-off in its margins in the first place.

Even as J.C. Penney Company, Inc. (NYSE:JCP) backtracks from Johnson’s audacious plan, it has decided to focus on a younger — and more fashionable — crowd than it has traditionally served. This is unlikely to play well with the company’s core customer base, and will probably lead to continued shortfalls in same-store sales.