How I follow Warren Buffett to find cheap tech stocks to buy

Buffett at the BRK AGM

Legendary investor Warren Buffett is not best known for his tech investments. But actually his largest shareholding, by far, is Apple. So far, that has also been a highly lucrative investment for him.

I think that the approach Buffett takes to investing can help inform me as I look for cheap tech shares to buy now for my portfolio. Here is how.

Value and share price

Buffett buys shares that he thinks offer him good value. So how does he decide whether he think a share is good value?

He looks at the long-term economic potential of a business. So, for example, if it makes products for which there will likely be sustained demand and that have a competitive advantage, it could be a lucrative business. Apple has several such advantages, such as its iconic brand and large installed customer base. Those give it pricing power, which helps it make big profits. Last year, the tech giant posted earnings of $95bn (£77bn a current exchange rates).

But an attractive business does not necessarily make for a rewarding investment. That depends on the price at which I buy the shares. That is why Buffett focuses on trying to buy shares in great businesses that are selling at an attractive share price.

Tech stocks to buy now

After recent falls in the price of many tech shares, I am applying this method when it comes to my own portfolio.

The nature of tech means a company can often build a unique competitive advantage. Whether it is a large user base, like Spotify, network effects such as those seen at Airbnb, or a proprietary operating system like Apple has, a successful company can turn a competitive advantage into a potential source of future profits.

Warren Buffett does not buy shares just because their prices have fallen. Rather, he looks at the long-term prospects for a business and decides whether buying a small slice of it at the current share price seems like it offers him attractive value.

Applying the Warren Buffett approach

To bring this to life, consider Google and YouTube owner Alphabet (NASDAQ: GOOG).

Buffett had a chance to see the potential in Alphabet before many investors. Its co-founders visited the Sage of Omaha at his headquarters many years ago. Indeed, the idea of using Alphabet as a holding company for a number of businesses beyond Google itself was based on Buffett’s approach at Berkshire Hathaway, inspired by that meeting.

Buffett told the 2019 Berkshire shareholders’ meeting that the company “screwed up” by not identifying the attractiveness of Alphabet shares earlier. But in fact, I think the shares remain attractive as a possible purchase for my own portfolio even now.

The business has strong brands, a large user base and economies of scale. Those give it pricing power that could help it make huge profits in future. At a price-to-earnings ratio just over 20, I do not think Alphabet is cheap. But I think it is attractively priced given the strong economic characteristics of the business.

That very strength is also a source of risk – regulatory bodies may try to break up Alphabet in years to come. But I think the tech titan is a classic Warren Buffett-style share. I would consider buying it for my portfolio.

The post How I follow Warren Buffett to find cheap tech stocks to buy appeared first on The Motley Fool UK.

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Christopher Ruane has no position in any of the shares mentioned. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. The Motley Fool UK has recommended Airbnb, Inc., Alphabet (A shares), Alphabet (C shares), Apple, and Spotify Technology. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.