Warren Buffett’s annual letter to shareholders of Berkshire Hathaway provides deep insights into how he and his partner Charlie Munger are thinking about investments.

His net worth is USD 91 billion (about Rs 6,50,000 crore). 99% of his net worth is invested in a single stock. At the age of 89, he doesn’t want to sell any part of his equity shares as he is optimistic on equities for the long term. Nor does he want anyone to sell his shares even after his death!

Does Warren Buffett do exactly opposite of what you are told to do – follow asset allocation principles like diversification and reduce exposure to equities with age? Or does he actually follow these rules? Let’s try to answer this.

Buffett’s annual letter to shareholders of Berkshire Hathaway provides deep insights into how he and his partner Charlie Munger are thinking about investments. This year’s letter is more insightful than ever. Some of their insights are direct and upfront. Others will have to be discovered by multiple readings of his letter.

Here are my 7 takeaways from this year’s Buffett letter.

Takeaway 1: Look for 20% earnings growth

Berkshire Hathaway, by definition, is a holding company and a diffuse conglomerate. It has over 70 operating subsidiaries and investments in over 50 other listed companies. In effect, the total portfolio is diversified across 120 companies with a return-on-equity of more than 20 percent on a weighted basis.

The portfolio is diversified across industries with the common thread of sustainable, predictable earnings with positive cash flows.

When you are building your portfolio, use this benchmark. Try and build a high-quality diversified portfolio with earnings growth of more than 20%.

Takeaway 2: Focus on operating earnings. Not on annual returns

Mostly everyone chooses risk assets – stocks and particularly mutual funds – by pre-dominantly looking at past performance. Buffett specifically advises you to ignore the quarterly or annual performance – either realised or unrealised – from investments.

The performance of an investment over a period of a year – which is, in his own words, nothing but the duration of “the revolution of the earth around the sun” — has no bearing on the quality and performance of an investment. So there is no reason why that should be a determining factor in your selection of investments.

On the contrary, Buffett re-iterates that returns from equities, while significant are unpredictable and highly irregular. Focus on operating earnings of the underlying businesses in your portfolio and not on annual returns to be a successful investor.

Takeaway 3: Concentrate when you have conviction

Berkshire’s allocation to financial stocks has been very high ever since the 2008 crisis. Besides its insurance business GEICO, Berkshire holds stakes in Bank of America, Wells Fargo, JP Morgan Chase among others, with total weightage to financial stocks coming in at almost 46%.

This is followed by technology, where Berkshire owns almost 25% and almost all of it to Apple.

The top 15 stocks account for almost 85 percent of his portfolio. Clearly, Buffett believes in running a focussed portfolio with both sectoral and company concentration not being an obstacle in his conviction bets.

Takeaway 4: Beware if you don’t satisfy these conditions!

Buffett says he is almost certain that over long periods, equities will outperform fixed income if the low-interest rate era continues. But if you want to profit from equities, he says you should meet three conditions:

(a) Be ready for a major fall in equity markets at any point of time – even a 50% or more fall can happen and should not unnerve you
(b) Don’t invest using borrowed money and

(c) You should be able to control your emotions during times of market panics and euphoria.

If you don’t satisfy these conditions, stay away from stocks.

Takeaway 5: If your medium-term cash flows are taken care of, age is no factor for asset allocation!

The core of financial planning wisdom revolves around the rule that exposure to equities should reduce as you age. For instance, there is the ‘100 minus age’ model, which says that if your age is 30, 70 % (100 – 30) of your portfolio should be in stocks. That translates to 60 percent at age 40 and so on.

Buffett has a different take on this subject. All of his wealth is tied to stocks even at his age. Why? Because, as he points out, if anyone’s medium-term cash flows are in place (like it does for him), age is not a factor when it comes to asset allocation.

Thus, tying your asset allocation to your goals and cash flows could be a better idea than to age.

Takeaway 6: Don’t try to do everything yourself. Play your core competency!

Most people believe making equity investments is an art that can be aced with some practice.

But Buffett, who counts several successful CEOs and board directors as his good friends, says he wouldn’t trust them to manage his money. For that, it is simply not their core competency.

We are all good at something or other and for most of us, that list can become rather long. The important thing to recognise is that if you are Bobby Fischer, you must play only chess to make money – the operative word being “only”. Play your core competency and when it comes to investments, let professionals take care of money.

Takeaway 7: Patience, Opportunity and Cash Levels

Buffett has maintained that Berkshire will always keep at least $20 billion in cash. Still, the company has a record $128 billion cash in hand. Why so? Is Buffett expecting a major crisis around? Far from it – as Buffett never gets into predicting the direction of the economy.

But his cash position means he is simply waiting to find the right opportunities. Though he has invested small amounts over the years, Buffett’s last significant acquisition was Precision Castparts for USD 32 billion in 2015. Now he is patiently waiting. To be a successful investor, you have to be a patient investor – both in terms of holding your investments and waiting for the right opportunities.

This article first appeared on Moneycontrol.com. Published here for our readers.

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