Recent upswing for Cost Plus (CPWM) has no apparent means of support

Investors love rebounds: The stock once had a lofty value that sets a high target but has dropped way down from that point and is now trying to make the journey a round trip.

Unfortunately, bounces tend to be unpredictable. While some stocks go full circle, others never come back.

If you can't tell the difference between a stock on the rebound and one taking a temporary pause in a nosedive, you might end up making a value play on a stock like Cost Plus, the furniture retailer whose stock has more than doubled since hitting a low at the start of November. Despite that sharp rebound, the stock is today's pick for Stupid Investment of the Week.

Stupid Investment of the Week examines the flawed thinking and troublesome characteristics that lead average consumers to make less-than-ideal decisions. While obviously not a purchase recommendation, neither is this column intended to be an automatic sell signal, as there are times when dumping a problematic security only deepens the trouble.

For most stocks, one worry would be capital-gains taxes from making a hasty exit, particularly when a stock has been through a steep rise. In the case of Cost Plus (CPWM), however, the bounceback still leaves the company well down for the year, so taxes won't be much of a concern for anyone who didn't have near-perfect timing when they bought in.

Cost Plus is a classic case of why average investors should be more concerned with fundamentals than with recent stock-price movements.

Cost Plus is a specialty retailer, selling casual home furnishings, entertainment products and more, in about 300 stores in 34 states, skewed toward the West Coast. (There are 10 stores in Western Washington.)

While many retailers are suffering through a sluggish economy and flagging consumer confidence, Cost Plus is in a particularly bad spot. With the housing market ailing — particularly in California — and with some 2.4 million homes nationwide left empty, demand for household items is waning.

But Cost Plus isn't really known for selling basic, everyone-has-to-have-some furniture; instead, it peddles items that are the most discretionary of discretionary purchases.

When money gets tight — and it's already there for a lot of consumers — this is the kind of shopping that people can most easily do without.

But Cost Plus can't live without those shoppers. With that troublesome economic outlook for the company, it's no surprise that the stock got hammered in 2007. Truth be told, however, CPWM shares have been crushed time and again over the last few years. The stock lost more than 21 percent in 2004, and has done worse every year since, shedding almost 47 percent of its value in 2005 and taking a 40 percent drop in 2006.

It was more of the same at the start of the year. The stock declined steadily for most of the year, with the bleeding picking up speed in the fall. Shares fell from over $11 per share to a 52-week low of $2.86 on Nov. 1, and then a funny thing happened.

For no apparent reason, the stock turned around. The economy hasn't picked up. There was no big plan to sell stores and raise cash.

When third-quarter revenues were released Dec. 3, they showed a slight increase in net sales but a decline in same-store sales. The company posted a net loss of nearly $14 million, which was ahead of the guidance management had issued, but worse than the same period in 2006. While the company has discussed its "turnaround strategy," there's not a lot of proof yet that it's going to work.

The big driver in the stock price would appear to be driven by people betting on a takeover and expecting a premium. Early in November, Restoration Hardware (RSTO) signed a merger agreement with an affiliate of Catterton Partners, a private-equity firm, which agreed to pay $6.70 per share at a time when the store chain's shares were selling for roughly $4 less. Sears Holdings has since come in with a slightly higher bid.

The premium paid for Restoration Hardware — even though its product line is different from Cost Plus — is the logical cause of CPWM's current pop.

With no shift in the economy, no change in the company's forecast, no dramatic reason for a turnaround — and only slightly reduced pressure from short sellers after the stock's price dropped below $5 per share — the bounce was unexpected. Moreover, the move has no apparent means of support.

"When a stock has a big move in price, it might create a situation where the valuation changes, but it doesn't really mean that anything important has changed with the stock," says Rob Plaza, retail analyst for Zacks.com, who has a six-month target price on CPWM of $2 per share. "You're looking at a bad balance sheet, a stock positioned at the epicenter of the retail problem area, you're swimming in the deep end of the pool with a whole lot of short sellers betting against you, and you're not sure if the turnaround strategy will have any real effect."

Those are signs of a stock moving on market noise, hardly the kind of issue for an average investor.

If there is good news for Cost Plus, it comes in two forms. First, while Restoration Hardware is a different kind of store, its deal does at least raise the specter of a possible buyout in the future. And current expectations for the stock are so low that any positive news could give the stock a little pop.

That's not enough reason for someone to take a flyer on the stock now. While not down 75 percent for the year — as it was at the start of November — shares are still off about 50 percent despite the recent jump. The stock recently stood 88 percent below its five-year high of $48.48, and there's just no way to come up with a scenario where the company turns the current upswing into new glory days, at least not in the near term and without a merger partner.

Says Plaza: "The products they sell are pretty nice and priced well, but it's a store full of stuff that you really don't need and, in this economy, that's the problem. No one really needs to shop there, and until the economy changes and they close some stores or get a cash infusion from somewhere, you can look at the bounceback and be impressed by it, but you shouldn't go off and buy because of it."

Chuck Jaffe is senior columnist for MarketWatch. He does not own or hold short positions in any securities covered by Stupid Investment of the Week. If you have a suggestion for Chuck Jaffe's Stupid Investment of the Week or a comment about this week's column, you can reach him at jaffe@marketwatch.com or Box 70, Cohasset, MA 02025-0070.