Eddie Lampert's latest bid to lift Sears

Eddie Lampert used to be the smartest investor in retailing, if not the best investor of his generation. That was the case last summer when shares of Sears (SHLD) hovered above $170. In his recent letter to shareholders, Lampert presented a chart showing that even as Sears stock collapsed in the latter half of last year, his five-year return on investment in Sears Holdings, the combination of Kmart and Sears, exceeded 900%. His return, in fact, beat that of every other major retailer.

No more. Since May, as Sears stock has tumbled to $74, another retailer, Urban Outfitters (URBN), has risen to trump Lampert's investment. Shares of the hot specialty retailer, at $32, are up more than eight-fold since 2003. Gamestop (GME), the fast-growing videogame retailer that FORTUNE recently wrote about, is not far behind. "I guess you're telling me I need to get moving," Lampert said when I called him this morning.

Indeed. Lampert, who runs an $11.5 billion hedge fund called ESL Investments, owns 65.6 million shares of Sears Holdings, worth $4.9 billion. He is one of America's most secretive investors - and to retail-industry veterans, a walking conundrum. While they criticize him for under-investing in Sears and Kmart, he cites the value of pruning until he discovers the right strategy to spend money on. "Only when you find something that leads to better results," he says, "do you get behind it with a significant amount of capital."

Lampert, 45, has made mistakes, as he readily admits. One error was ramping up inventory last year, while failing to anticipate a drop in consumer spending. Another mistake was buying back 33 million Sears Holdings shares at an average price of $132 between 2004 and 2007. (Ouch.) But Lampert, who made his billions by playing contrarian, refuses to let the rising chorus of critics distract him. "We're the $50 billion company that people think doesn't have any customers or relevance," he says.

Even as Lampert loses customers to Wal-Mart (WMT) and Target (TGT), among other rivals, Sears has lots going for it: plenty of cash, relatively low debt, vast real estate (now is not the time to sell, obviously) and maybe most important, its private-label brands. Kenmore appliances, Craftsman tools, DieHard batteries and Lands' End, the clothing maker, are leaders in their categories. Since only Sears and Kmart carry them, however, these brands have serious distribution challenges. "We have to increase awareness and make them more accessible," says Lampert, who operates out of a spare hedge-fund office in Connecticut but nonetheless is a hands-on Sears chairman.

A new strategy for the brands may be coming. In addition to searching for a new CEO (Russell Reynolds is conducting the Sears CEO search - and it's slow going), Lampert disclosed that he is looking for an executive to oversee the company's multi-billion bevy of private brands. He needs a brand ace to figure out how to innovate and distribute them more broadly. One option, actually, was debated at Yale professor Jeffrey Sonnenfeld's recent CEO Summit in New York. There, brand experts from India - including a renowned professor and a prominent industrialist - said that Indian investors are eager to expand into retailing globally and would likely be interested in owning, or at least carrying, brands like Craftsman and Kenmore.

"Fascinating," says Lampert. As for the opportunity, he uttered only that. As you read this, he is probably contemplating the possibilities.

P.S. At the Yale CEO Summit, participants voted on this question: Is Sears fixable? Forty percent said yes. Sixty percent said no. How would you vote?