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Leaked: Warren Buffett’s Recipe for Financial Success

Warren Buffett

All too often, investors only think about the businesses Berkshire Hathaway runs that have brand names that are easily recognisable (for the American public, at least). Dairy Queen. Geico. Heinz. But one of its businesses you’ve likely never heard of has a simple but remarkable history of success.

The big business that could

In May of 2006, for US$4 billion, Warren Buffett’s Berkshire Hathaway agreed to acquire 80% of Israel-based International Metalworking Companies (IMC), which provides metal cutting tools through ISCAR and other brands for business across the globe. The remaining 20% would be owned by the family. And it was in the 2006 letter to shareholders detailing why Berkshire made the purchase when Buffett wrote the quote found below:

ISCAR makes money because it enables its customers to make more money. There is no better recipe for continued success.”

Eitan Wertheimer, the chairman of IMC and member of the family who started it, wrote Buffett a 1.25 page letter asking if he’d like to buy it in 2005. In Buffett’s own words, it has a “simple and profitable business model”; he and Charlie Munger (Berkshire Hathaway’s vice-chairman and Buffett’s long-time business partner) couldn’t turn it down when the opportunity to acquire it arose.

ISCAR makes a variety of small tools that are used by customers — largely in the automotive, aerospace, and mold industries — that operate massive machines for metal working. And while its “groove-turn,” “turning & threading,” “hole making,” “milling,” and “tool holding,” businesses won’t grab headlines, its recipe for success should.

The recipe for success

In 2009, as the global economy spun downwards (Singapore wasn’t spared either), Buffett noted even though Iscar’s results were “down significantly from 2008,” he continued, “when manufacturing rebounds, Iscar will set new records.” That didn’t take long: Its profits rose by a staggering 159% in 2010.

So, how did it do that? Let’s take another look at Buffett’s words:

“ISCAR makes money because it enables its customers to make  more  money. There is no better recipe for continued success.”

Buffett has long touted the benefit of GEICO providing the least expensive automobile insurance policy – an unwanted requirement for Americans – which has allowed it to take over the auto insurance industry little by little. In this year’s letter, he said:

“GEICO’s cost advantage is the factor that has enabled the company to gobble up market share year after year. Its low costs create a moat — an enduring one — that competitors are unable to cross.”

And while it’s a touch different, it’s this business model that has allowed ISCAR to be successful. It provides value to its customers by ensuring there is a true benefit to their bottom lines when they use its products. It may not offer the cheapest tools, but it offers those with the most value.

Taking a step toward another Berkshire Hathaway investment consider, USG , or United States Gypsum Corporation. This non-exciting business manufactures drywall and other construction materials for residential and commercial properties. Like ISCAR, it isn’t anything exciting, but it provides, “low-cost capacity and market-leading brands,” which allows it to provide value to its customers. And as a result, it’s “a leader in each of its three core businesses.”

So why bring up USG? While it too may be a small company that doesn’t grab headlines, it’s clearly one Buffett believes in. The US$1.1 billion common stock position held by Berkshire Hathaway represents an ownership stake of more than 30%.

The key takeaway

Last year, Warren Buffett shelled out US$2.1 billion to buy the remaining 20% of IMC, meaning its value had more than doubled since 2006. Buffett said it “has enjoyed very significant growth over the last seven years,” and he was “delighted to acquire,” the remaining 20%.

Before you make your next investment, ask yourself if that business provides true and immediate value to its customers. In Singapore companies like Sarine Technologies (SGX: U77) and Breadtalk (SGX: 5DA) can also be said to be businesses that belong to such a category.

Sarine Technologies designs and manufactures capital equipment that diamond manufacturers use to improve their production yields (and by extension, their profits; diamond manufacturers have the lowest profit margins in the diamond industry’s value chain, so any improvement for them would be very valuable) in the process of converting rough diamonds into polished diamonds. Meanwhile Breadtalk, through its namesake bakery and Din Tai Fung restaurants amongst other concepts, offers affordable pastries, breads, and Chinese restaurant fare for consumers – that’s providing value too.

Although their futures can be up for debate, both shares have certainly been long-term winners in the share market. Since the start of 2007, Sarine Technologies and Breadtalk have gained 483% and 547% in price respectively; by way of comparison, the Straits Times Index (SGX: ^STI) has merely grown by 10% from 2,986 points to 3,271 points.

To reiterate, ask yourself if any business you’re interested to invest in provides true and immediate value to its customers. If it does, the odds of a owning a long-term winner tip in your favour.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. This article’s written by Patrick Morris and first published on Fool.com. It has been edited for fool.sg.