I want to personally invite you to our 2015 Investor Conference, which will be held this November in Las Vegas. This conference regularly sells out. If you can attend, you will be treated to many great presentations. Among the speakers at this year’s conference are Jack Ablin of BMO, Larry Swedroe of the Bam Alliance and Christine Benz of Morningstar. I hope to see you there!

Warren Buffett’s annual letter to Berkshire-Hathaway (BRK.B) shareholders is on my must-read list, and I suggest adding it to yours as well. The letter always provides investing insights on Buffett’s folksy but outspoken manner. This year’s letter included special commentary from both Buffett and his partner Charlie Munger.

I’m going to give a few highlights in this week’s Investor Update both from the 50th anniversary commentary and the “traditional part" of the letter. This will be a mere sampling mixed in with observations from me. It is not, nor is it meant to be, a substitute for the real thing. This is why I encourage you to read the actual letter—even if you are not a Berkshire-Hathaway shareholder, as I am.

One of the most interesting pieces was Buffett’s discussion of his mistakes. Right off the bat in his reflection of 50 years as CEO, he described his decision not to sell his stake in Berkshire Hathaway (then just a textile manufacturer) as “a monumentally stupid decision.” Buffett bought shares on the cheap and when his investment thesis played out, Buffett refused to sell at a profit. Rather, he did the exact opposite and bought more shares. Buffett ended up owning a troubled company that he admittedly didn’t know much about. He described himself as having become “the dog who caught the car.”

Another mistake Buffett admitted was buying Waumbec Mills on the belief that “synergies” would result in a profitable investment. Cost savings have been a continuous argument from corporate executives as to why shareholders should support their acquisition decisions. Often, however, synergies don’t come to fruition. Or as Buffett put it, “I’ve never heard ‘dis-synergies’ mentioned, though I’ve witnessed plenty of these once deals have closed.”

Mergers and other types of corporate restructuring were a big a topic in this year’s letter. Berkshire Hathaway is a conglomerate set up to pool the excess cash thrown off by each holding to fund potentially profitable endeavors. The unique structure of the company and the talents of Buffett and Munger allow capital to be deployed in a manner that is tax-friendly and without transaction costs. It is a characteristic Buffett routinely touts in his shareholder letters.

In discussing mergers, the Oracle of Omaha brought up the topic of creative accounting. He particularly focused on companies issuing shares to grow their businesses, stating, “We have never invested in companies that are hell-bent on issuing shares. That behavior is one of the surest indicators of a promotion-minded management, weak accounting, a stock that is overpriced and–all too often–outright dishonesty.”

Buffett also used Jimmy Ling, who made a habit of acquiring and divesting companies in the 1960s and 1970s, as an example as to why investors should be weary of CEOs who use creative business strategies. “Periodically, financial markets will become divorced from reality–you can count on that. More Jimmy Lings will appear. They will look and sound authoritative. The press will hang on their every word. Bankers will fight for their business. What they are saying will recently have ‘worked.’ Their early followers will be feeling very clever. Our suggestion: Whatever their line, never forget that 2+2 will always equal 4. And when someone tells you how old-fashioned that math is—zip up your wallet, take a vacation and come back in a few years to buy stocks at cheap prices.”

Buffett and Munger were also critical of the environment that encourages various corporate restructurings. Buffett wrote, “Investment bankers, being paid as they are for action, constantly urge acquirers to pay 20% to 50% premiums over market price for publicly-held businesses. The bankers tell the buyer that the premium is justified for ‘control value’ and for the wonderful things that are going to happen once the acquirer’s CEO takes charge. (What acquisition-hungry manager will challenge that assertion?)…A few years later, bankers–bearing straight faces–again appear and just as earnestly urge spinning off the earlier acquisition in order to ‘unlock shareholder value.’”

Munger says the culture of resistance to such deals is what has helped Berkshire’s success: “Berkshire, by design, had methodological advantages to supplement its better opportunities. It never had the equivalent of a ‘department of acquisitions’ under pressure to buy. And it never relied on advice from ‘helpers’ sure to be prejudiced in favor of transactions.”

Perhaps the biggest reason many of us read the Berkshire shareholder letters in their entirety is that there are often good nuggets of advice intermingled with the commentary that could be missed if one were to simply scan the monologue. This year’s letter was no different, with Buffett cautioning on page 34 that “A sound investment can morph into a rash speculation if it is bought at an elevated price.” This is a quote you would do well to look at every time before you place an order to buy an investment.

• Insights on Warren Buffett from His Friend and Editor – Carol Loomis, who edits Buffett’s annual letter, spoke about his investing and management process.
  
• Is the Stock Market Efficient? – Georgetown professor Prem Jain says that while Buffett doesn’t believe beating the market is easy, there are ways to achieve above-average returns
  
• Do You Incorporate Buffett’s Concepts Into Your Investing Strategy? – Tell us on the AAII.com Discussion Boards.
  

I will speak to our Albuquerque chapter on Monday. Not in the Albuquerque area? Our Local Chapters page can help you find a meeting in your area.

Just two S&P 500 companies will report earnings next week: Urban Outfitters (URBN) on Monday and Dollar General (DG) on Thursday.

The first economic reports of note will be the January Job Openings and Labor Turnover Survey (JOLTS) and January wholesale trade, on Tuesday. Thursday will feature February retail sales, February import and export prices and January business inventories. The February Producer Price Index and the preliminary March University of Michigan consumer sentiment survey will be released on Friday.

Cleveland Federal Reserve Bank President Loretta Mester will speak publicly on Monday.

The Treasury Department will auction $24 billion of three-year notes on Tuesday, $21 billion of 10-year notes on Wednesday and $13 billion of 30-year bonds on Thursday.

The percentage of investors describing their short-term outlooks as "bearish" rose for a second consecutive week, according to the latest AAII Sentiment Survey. The rise is occurring after pessimism had fallen to unusually low levels.

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 5.6 percentage points to 39.8%. The drop puts optimism at a four-week low. Nonetheless, bullish sentiment is still above its historical average of 39.0% for the 26th out of the last 30 weeks.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rebounded by 2.5 percentage points to 36.8%. This week is the ninth consecutive week with neutral sentiment above its historical average of 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose by 3.1 percentage points to 23.4%. The rise puts pessimism at a four-week high. Nonetheless, this is the 43rd week out of the past 52 with a bearish sentiment reading below its historical average of 30.5%.

Bearish sentiment has risen by a cumulative 5.5 percentage points over past two weeks. As noted above, the rebound is occurring after pessimism reached an unusually low level of 17.9% on February 19, 2015. Over the same period, bullish sentiment has fallen by a cumulative 7.2 percentage points.  Even with these shifts, pessimism is still well below its historical average (though within its typical range), while optimism is slightly above its historical average.

Keeping AAII members encouraged are the upward momentum of stock prices, comparatively low energy prices, earnings growth and sustained economic expansion. Causing other members to be cautious or pessimistic are prevailing valuations, disappointing earnings or guidance from certain companies, geopolitical events, the impact of lower oil prices on energy stocks, the pace of economic growth and worries that an even larger decline in stock prices could occur.

This week’s special question asked AAII members how fourth-quarter earnings have influenced their six-month outlook for stocks. Responses were mixed, with 37% of respondents saying the profit reports have not influenced their outlooks. Many of these individual investors said other factors were more influential, such as geopolitics, valuations and monetary policy. Nearly a quarter (24%) of respondents said fourth-quarter earnings negatively impacted their outlook, with the impact of the stronger dollar being the primary reason. Just under 15% were encouraged by last quarter’s earnings, with many saying the results confirmed that growth was still occurring.

Here is a sampling of the responses:

• “No influence. I’m much more concerned about global issues.”
• “Earnings are being pressured by the rising dollar.”
• “Not much. Some earnings have been dampened by currency fluctuations. I view this as temporary noise.”
• “Reinforced the notion that large-cap companies are in good shape.”

Bullish: 39.8%, down 5.6 points
Neutral: 36.8%, up 2.5 points
Bearish: 23.4%, up 3.1 points


Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%

Last month, equity allocations within individual investors’ portfolios rebounded back to their second-highest level since the financial crisis. The February AAII Asset Allocation Survey showed a rise in stock and stock fund holdings, a decline in fixed-income holdings and no change in cash allocations.

Stock and stock fund allocations rebounded by 1.1 percentage points to 68.3%. This ties December 2013 for the second-highest allocation to equities since June 2007. Last month was also the 23rd consecutive month and the 25th out of the past 26 months with stock and stock fund allocations at or above their historical average of 60%.

Bond and bond fund allocations declined by 1.1 percentage points to 16.4%, a three-month low. Even with the decrease, bond and bond fund allocations remained at or above their historical average of 16% for the ninth consecutive month.

Cash allocations were unchanged at 15.3%. February was the 39th consecutive month with cash allocations below their historical average of 24%.

The increase in stock and stock fund allocations is not surprising given the background factors at play. The S&P 500 gained 5.5% last month and experienced its best February performance since 1998. Optimism in our weekly Sentiment Survey was above its historical average for most of the month as well. Bond yields, though rising in February, were at low levels at the end of January.

Last month’s special question asked AAII members what predominately influences their decision to increase or decrease their exposure to stocks and stock funds. Responses were mixed, with some members giving more than one reason. Market conditions were cited by about 19% of all respondents. A nearly equal number pointed to market direction (9%) as did valuation (8%). The attractiveness of equities or individual stocks were given as a reason by about 19% of all respondents as well. Many of these members cited expected returns as playing a role. Slightly more than 13% of all respondents said their age influences their allocation. Roughly 11% said economic conditions play a role, while 10% said they maintain or rebalance to a targeted allocation.

• Stocks and Stock Funds: 68.3%, up 1.1 percentage points
• Bonds and Bond Funds: 16.4%, down 1.1 percentage points
• Cash: 15.3%, unchanged

• Stocks: 33.9%, up 2.9 percentage points
• Stock Funds: 34.4%, down 1.8 percentage points
• Bonds: 3.3%, up 0.2 percentage points
• Bond Funds: 13.1%, down 1.3 percentage points

Take the Asset Allocation Survey.

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