Archives for August 2018

New OpenStack cloud release embraces bare metal

OpenStack is getting bigger than ever. It now powers more than 75 public cloud data centers and thousands of private clouds at a scale of more than 10 million compute cores. But it’s always been hard to upgrade from one version of OpenStack to another, and it’s been hard to deploy on bare metals. With OpenStack 18, Rocky, both problems are much easier to deal with now.

The open-source OpenStack cloud, like its ancestors, has always run well on diverse hardware architectures — bare metal, virtual machines (VMs), graphics processing units (GPUs), and containers. Bare metal was always a bit tricky. OpenStack Ironic, its bare metal provisioning module, is bringing more sophisticated management and automation capabilities to bare metal infrastructure. Nova, which provisions compute instances, now supports creating both virtual machines (VM)s and bare metal servers. This means it also supports multi tenancy, so users can manage physical infrastructure in the same way they manage VMs.

Also: Open-source community has an integration problem: OpenStack

Other new Ironic features include:

  • User-managed BIOS settings: BIOS (basic input output system) performs hardware initialization and has many configuration options that support a variety of use cases when customized. Options can help users gain performance, configure power management options, or enable technologies like single root input/output virtualization (SR-IOV) or Data Plane Development Kit (DPDK). Ironic also enables users to manage BIOS settings, supporting use cases like Network Functions Virtualization (NFV) and giving users more flexibility.
  • Conductor groups: In Ironic, the “conductor” is what uses drivers to execute operations on the hardware. Ironic has introduced the “conductor_group” property, which can be used to restrict what nodes a particular conductor (or conductors) have control over. This allows users to isolate nodes based on physical location, reducing network hops for increased security and performance.
  • RAM Disk deployment interface: A new interface in Ironic for diskless deployments. This is seen in large-scale and high performance computing (HPC) use cases when operators desire fully ephemeral instances for rapidly standing up a large-scale environment.

Julia Kreger, Red Hat principal software engineer and OpenStack Ironic project team lead, said in a statement, “OpenStack Ironic provides bare metal cloud services, bringing the automation and speed of provisioning normally associated with virtual machines to physical servers. This powerful foundation lets you run VMs and containers in one infrastructure platform, and that’s what operators are looking for.”

This isn’t just theory. It works. And it heading into production.

James Penick, Oath’s IaaS architect (Oath is AOL and Yahoo’s parent company), said Oath is already using OpenStack to manage “hundreds of thousands of bare metal compute resources in our data centers.” He added, “We have made significant changes to our supply chain process using OpenStack, fulfilling common bare metal quota requests within minutes.”

That’s good, but it’s not good enough.

“We’re looking forward to deploying the Rocky release to take advantage of its numerous enhancements such as BIOS management, which will further streamline how we maintain, manage and deploy our infrastructure,” Penick said.

Also: How to install OpenStack on Ubuntu Server with Devstack TechRepublic

That’s great, but many OpenStack users are already saying, “Maybe I’ll install this in 2021.”

Upgrading OpenStack isn’t easy. But OpenStack Rocky’s Fast Forward Upgrade (FFU) feature is ready for prime time, and it’s all set to help users overcome upgrade hurdles and get on newer releases of OpenStack faster. Now, FFU lets a OpenStack on OpenStack (TripleO) user on Release “N”, and they can quickly speed through intermediary releases to get on Release “N+3” (the current iteration of FFU being the Newton release to Queens). You can’t jump all the way to Rocky, but you can a lot closer to it more quickly than you ever could before.

Other new features are:

  • Cyborg provides lifecycle management for accelerators like GPUs, FPGA, DPDK, and SSDs. In Rocky, Cyborg introduces a new REST API for FPGAs. These floating point chips are used machine learning, image recognition, and other HPC use cases. This enables users to dynamically change the functions loaded on an FPGA device.
  • Qinling is introduced in Rocky. Qinling (“CHEEN – LEENG”), a function-as-a-service (FaaS) project. This delivers serverless capabilities on top of OpenStack clouds. It also enables developers to run functions on OpenStack clouds without managing servers, VMs or containers — while still connecting to other OpenStack services like Keystone.
  • Masakari, which supports high availability by providing automatic recovery from failures, expands its monitoring capabilities to include internal failures in an instance, such as a hung OS, data corruption, or a scheduling failure.
  • Octavia, the load balancing project, adds support for UDP (user datagram protocol). This brings load balancing to edge and IoT use cases.
  • Magnum, a project that makes container orchestration engines and their resources first-class resources in OpenStack, has become a Certified Kubernetes installer. This makes it easier to deploy Kubernetes on OpenStack.

Want to check the new OpenStack out? You can download Rocky today.

Related Stories:

Amazon: $2 Trillion By 2020?

I have always had a hard time making sense of Amazon (AMZN) as an investment vehicle. I continue to believe that talking about the company and the stock in terms of next quarter’s earnings or this year’s revenues is futile. After all, a forward P/E of 110x or an EV/sales of 4.0x (on razor-thin margins) could only lead to one logical conclusion: AMZN is an overpriced stock to avoid.

Credit: ABC 13 Eyewitness News

Roughly one year ago, I argued instead that investing in Amazon required “2020 vision”. That meant that, in my opinion, one must try and project the company’s results at least three years out in the future, ideally more, to decide whether buying the stock today makes sense.

To do so, I revisit my 2025 projections from back in the early part of 2017 and make adjustments given the developments of the past one and a half year. By doing so, I hope to answer (or at least take a stab at answering) a couple of key questions: does AMZN deserve its nearly $1 trillion valuation? And if so, can the stock continue to head up, perhaps at the same 44% per year pace that it has experienced in the past five years?

Deeper roots in North America

The North America segment represented a sizable 60% of Amazon’s total revenues in 2017, and its growth, surprising to some, has not shown any sign of slowing down. The company seems to have used a strategy of horizontal expansion to keep momentum going strongly – think, for example, of the Whole Foods acquisition that not many saw coming, or Amazon’s head-first dive into content creation and distribution with Prime Video. Despite the richer fulfillment, marketing, and content costs that the growth strategy demands, the North America segment has seen unadjusted operating profits rise by a factor of four YOY last quarter.

Last year, I believed Amazon could deliver what now seems like a very timid 20% revenue increase in 2018 that would slowly dwindle to the low single digits by 2025. Today, I recognize that my expectations have been set too conservatively: growth in the first half of 2018 has reached an impressive 45% already – although comps should get tougher by this year’s holiday season. I now do not expect the revenue increase to dip below 10% until 2025, with near-term prospects looking much rosier than I originally envisioned.

International expansion

This is perhaps Amazon’s least developed segment. After having transformed the retail landscape and disrupted other industries (like media) in the U.S. and neighboring markets, quite a bit more work is left to be done beyond the North American borders. Roughly 18 months ago, when international sales of $44 billion in 2016 had been growing at a 24% clip, the company’s CFO spoke of fulfillment expansion being more balanced between domestic and global in order to address the international opportunity.

Since then, international revenues have increased at an average 25% rate over the past six quarters, with the most recent holiday season (one of Amazon’s most impressive) experiencing robust growth of 29% that was followed by 1Q18’s even better 34%. Amazon seems to have a blank canvas in terms of what product or service initiatives it may choose to pursue in what countries – it seems to me that Prime and Alexa-enabled devices have been key priorities. Also very importantly, scale (of fulfillment infrastructure and marketing efforts, for example) is finally providing some lift to profitability, and GAAP operating loss has started to narrow.

In 2017, I foresaw international revenue growth landing at 30% in 2018 and declining steadily towards GDP-like growth within eight years. Today, I maintain my expectations for top-line growth in the near term but see it declining at a less steep trajectory in the coming years.

AWS execution

If I ever considered buying AMZN in the past, Web Services was likely a key reason to do so – I elaborated further in my two-year-old but still relevant 2016 article on the subject. The relatively small segment (12% of total revenues in 2Q18) is an able generator of op profits (55% of total company’s last quarter) and gains of scale here are likely to support Amazon’s margins going forward.

As it turns out, my mild fears over fierce competition and price pressures in the cloud storage, and computing spaces have proven to be a bit overdone. Amazon has been able to reignite growth in AWS in the past three to four quarters, as the graph below illustrates. This was probably enabled by a combination of the secular transition to cloud solutions, a strong macroeconomic environment that has encouraged digital infrastructure investments, and Amazon’s competence at providing a good product at a competitive price despite the success of competing services like those of peer Microsoft (MSFT).

I now expect cloud services growth to surpass the 40% mark in 2018, with the decline over the next eight years averaging about four percentage points per year. See historical trend in AWS revenues and top-line growth below.

Source: DM Martins Research, using data from company reports

Plugging in the numbers

As evidenced in the narrative above, Amazon has delivered well beyond my early 2017 expectations. Despite the size of the company, one of the largest in the world, there seems to be quite a lot of revenue and op profit growth opportunities yet to be realized, from horizontal expansion domestically to international penetration to gains of scale driving increased margins.

Looking at the near term first (i.e. next 12-18 months), I believe the Street’s expectations for 2019 revenue growth of 22% suggests to me a significant deceleration in Amazon’s footprint expansion – something that I find unlikely, absent a more severe deterioration in macroeconomic fundamentals. Therefore, I would not be surprised to see upward revisions in top-line estimates in the upcoming months, should Amazon continue to execute as well as it has over the past few years.

Switching to the long term (two to five years at least), I don’t find it unreasonable to project double-digit revenue growth through 2025 which, coupled with expanding margins, might conceivably produce what I estimate might be $40 in EPS by 2021 (roughly $20 billion in net income and 500 million shares outstanding) vs. $25/share projected for next year. Should Amazon be able to deliver against this aggressive growth benchmark, it is unlikely that its stock would suffer much in terms of multiple contractions. At a forward earnings multiple of 100x, EPS of $40 would imply $2 trillion in market cap by the end of 2020 – roughly 37% annualized share price appreciation that looks doable in the context of trailing five-year trends.

Those optimistic enough to believe that the Amazon story has barely begun may find today’s valuation justifiable and see an investment in the stock still enticing. To them, AMZN may have lost the race to $1 trillion in market cap to Apple (AAPL). But if all goes well, the stock could still rush ahead and beat its peer at becoming the first ever $2 trillion company.

Disclosure: I am/we are long AAPL, MSFT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I may own AMZN indirectly through passive ETFs (exchange-traded funds).

Micron Technology plans $3 billion expansion of Virginia plant

(Reuters) – Chipmaker Micron Technology Inc said Wednesday it plans to spend $3 billion over the next 12 years to expand a plant in Virginia about 40 miles (64 km) west of Washington, D.C.

FILE PHOTO – Memory chip parts of U.S. memory chip maker MicronTechnology are pictured at their booth at an industrial fair in Frankfurt, Germany, July 14, 2015. REUTERS/Kai Pfaffenbach/File Photo

Chief Executive Sanjay Mehrotra told Reuters in an interview the expansion aims to meet increasing demand for chips in automobiles, which are gaining more computer power for features such as collision avoidance systems or lane departure warning systems. The company expects that market to double to $6 billion by 2021.

“Think of the automobiles of the future as data centers on wheels,” he told Reuters.

The money will be spent to build about 100,000 square feet of additional “clean room” space for making memory chips at Micron’s existing Manassas, Virginia factory, which employs about 1,500 people. Micron expects the expansion to create 1,100 permanent jobs for engineers and technicians once complete.

Boise, Idaho-based Micron, the world’s fourth largest semiconductor firm by revenue according to research firm Gartner, differs from much of the chip industry in that it still makes its own chips rather than farming the work to contract factories and that it still makes many of its chips in the United States. It also makes chips in Singapore, Japan and Taiwan, but only performs assembly and test work in China.

The company has become a prominent point in trade relations between China and the United States. Micron in 2015 rejected a takeover bid made by a state-backed Chinese company as China was trying to build out its chip industry, a development that the U.S. Trade Representative Robert Lighthizer highlighted in a report in March about China’s trade practices.

Micron later alleged in a U.S. lawsuit that a different Chinese firm stole its trade secrets. That firm in turn sued Micron in a Chinese court alleging Micron violated its patents, and the Chinese court banned some of Micron’s chips while the trial proceeds.

U.S. officials brought up Micron’s story during trade talks with Chinese trade officials earlier this month, according to two people familiar with the talks.

Mehrotra said the decision to expand in Virginia “really does not have anything to do with the recent discussions with China on various trade matters.” Instead, he said, Virginia was chosen for expansion because it has been making chips for 15 years there for car makers, who demand higher levels of durability and reliability than gadget makers.

“We have a deep culture in the Manassas facility of supporting the demanding requirements of these customers,” he said.

Reporting by Stephen Nellis and David Lawder in Washington; Editing by Lisa Shumaker

White House investigating Google after Trump accuses it of bias

WASHINGTON (Reuters) – U.S. President Donald Trump said on Tuesday Google’s search engine was hiding “fair media” coverage of him and said he would address the situation, taking a swipe at the internet giant without providing evidence or giving details of action he might take.

FILE PHOTO: FILE PHOTO: The logo of Google is pictured during the Viva Tech start-up and technology summit in Paris, France, May 25, 2018. REUTERS/Charles Platiau/File Photo

The company, part of Alphabet Inc, denied any political bias in its search engine.

Trump’s economic adviser, Larry Kudlow, later told reporters that the White House was “taking a look” at Google, saying they would do “some investigation and some analysis,” without providing further details.

Trump’s criticism and threat of action to somehow restrict Google was his latest attack on a major tech company, following a series of tweets about Amazon.com, which he has accused of hurting small businesses and benefitting from a favorable deal with the U.S. Postal Service.

Last week, without mentioning specific companies, he accused social media companies of silencing “millions of people” in an act of censorship, without offering evidence to support the claim.

In several tweets on Tuesday, the president said Google search results for “Trump News” showed only the reporting of what he terms fake news media, saying this was rigged against him and others.

Blaming Google for what he said was dangerous action that promoted mainstream media outlets such as CNN and suppressed conservative political voices, Trump added, “This is a very serious situation-will be addressed!” He did not offer any details.

Google said in a statement that its search engine “is not used to set a political agenda and we don’t bias our results toward any political ideology … We continually work to improve Google Search and we never rank search results to manipulate political sentiment.”

U.S. member of Congress Ted Lieu, a Democrat, said in a tweet directed at Trump: “If government tried to dictate the free speech algorithms of private companies, courts would strike it down in a nanosecond.”

Shares of Alphabet fell 0.3 percent to $1,252.98.

TRUMP’S CRITICISM OF MEDIA

While the exact science behind Google searches on the internet is kept secret, its basic principles are widely known. Search results on Google are generated by a variety of factors measured by the company’s algorithms.

They include determining a site’s relevance by counting the number of links to the page. Other factors such as personal browsing history and how certain keywords appear on the page also affect how pages are ranked. Popular news sites such as CNN.com and NYTimes.com, which many readers link to, can appear higher in searches based on such factors.

FILE PHOTO: FILE PHOTO: U.S. President Donald Trump listens to a question during an interview with Reuters in the Oval Office of the White House in Washington, U.S. August 20, 2018. REUTERS/Leah Millis/File Photo

Trump has long criticized news media coverage of him, frequently using the term fake news to describe critical reports. Earlier this month, he accused social media companies, which include Twitter Inc and Facebook Inc, of censorship.

Trump’s accusation of bias on the part of Google comes as social media companies have suspended accounts, banned certain users and removed content as they face pressure from the U.S. Congress to police foreign propaganda and fake accounts aimed at disrupting American politics, including operations tied to Iran and Russia.

Companies such as Facebook and Twitter have also been pressed to remove conspiracy driven content and hate speech.

Tech companies have said they do not remove content for political reasons.

Some Republican U.S. lawmakers have also raised concerns about social media companies removing content from some conservatives, and have called Twitter’s chief executive to testify before a House of Representatives panel on Sept. 5.

Earlier this month, Alphabet’s YouTube joined Apple Inc and Facebook in removing some content from Infowars, a website run by conspiracy theorist Alex Jones. Jones was also temporarily suspended on Twitter.

Trump and the White House did not provide any detail on how they would probe Google, but the new Republican chair of the Federal Trade Commission, Joseph Simons, said in June that the agency would keep a close eye on big tech companies that dominate the internet.

Reporting by Susan Heavey; Additional reporting by Ken Li in New York and Chris Sanders in Washington; Editing by Frances Kerry

5 Reasons This Fast Growing Blue Chip Is One Of The Best Tech Stocks In The World

(Source: imgflip)

While my income growth retirement portfolio is focused on higher-yielding stocks, history shows that lower-yielding but fast-growing dividend growth stocks are also a great way to exponentially compound your wealth over time.

For example, between 1969 and 2011, dividend growth stocks yielding less than 3% managed to be the second best performing group of stocks. They beat the S&P 500 by about 3% per year over this 42 year period. They also did so with the second best risk-adjusted returns (returns/volatility), as shown by this group’s information ratio.

This is why I want to highlight Microsoft (MSFT), one of my favorite blue chip tech dividend growth stocks. Thanks to its strong rally this year, the stock’s yield is rather paltry.

Chart

MSFT Total Return Price data by YCharts

However, there are five reasons why I still think the company remains an attractive long-term income growth investment. In fact, even from today’s elevated prices, I think Microsoft might realistically achieve about 16% annualized total returns over the next decade. That’s not just likely to significantly beat the market over that time period, but potentially quadruple your money over the next 10 years.

Most importantly, the company’s strong fundamentals and likely decades long growth runway mean that Microsoft is as close to a “buy and hold forever” stock as you can find on Wall Street.

1. Short-Term Growth Engine Firing On All Cylinders

Replacing Steve Ballmer with Satya Nadella in 2014 turned out to be a master stroke. That’s because Nadella was the head of Microsoft’s cloud division and shifted the company’s focus from its legacy Windows business to cloud/software as a service subscription model. The results speak for themselves.

(Source: Microsoft Earnings Presentation)

Microsoft, despite its massive size, is seeing strong top line growth with revenue rising 17% in the past quarter (YOY). More importantly, its bottom line is growing as well. Thanks to sales outpacing cost growth, both the gross margin and operating margin expanded, resulting in a 30% boost to operating income. Note that operating income excludes the beneficial effects of tax cuts. Thus, this year this is the more important metric for investors to focus on.

The biggest reason for Microsoft’s massive operating profit growth was its success in converting its over 1 billion global Windows users to its cloud subscription service. The company’s commercial unit, which has 89% of revenue from recurring subscriptions, saw its sales soar 53%. More importantly, its gross margins on those sales also rose by 6% over the past year to an impressive 58%. This shows that Microsoft enjoys a wide moat that gives it strong pricing power (more on this in a moment).

(Source: Microsoft Earnings Presentation)

The heart of Microsoft’s commercial success is its fast growing intelligent cloud business. Not just is this growing at double digits, but that growth rate accelerated to 26% YOY in the latest quarter.

(Source: Microsoft Earnings Presentation)

Meanwhile, operating margins on cloud, despite aggressive capex investment, are also rising. This is why Microsoft’s cloud business (which accounted for 21% of revenue in the past 12 months) saw operating profits rise 34%.

(Source: Microsoft Earnings Presentation)

The company’s success in cloud is due to torrid growth in Azure, its cloud computing/artificial intelligence data analytics platform. Azure is the world’s second fastest growing cloud platform and continues to increase at nearly triple digit rates. In comparison, Amazon’s (AMZN) AWS cloud platform, currently the largest in the world, is growing at 49%. This indicates that Microsoft is gaining market share in what’s arguably one of the most important industries of the coming century.

Part of the company’s strategy involves continually adding new services to increase the strength of its cloud offering. Or to put another way, Microsoft wants its suite of cloud offerings to become a one stop shop “walled garden” ecosystem that locks in customers for the long term. This is why it bought LinkedIn back in 2016.

(Source: Microsoft Earnings Presentation)

Microsoft’s controversial $26.2 billion acquisition of LinkedIn also appears to be paying off. Thanks to a 41% increase in engagements from its 575 million member base, this business saw 37% revenue growth which outpaced its 17% increase in operating costs. As a result, operating losses at LinkedIn fell 49%, and this acquisition is on track to become accretive to Microsoft’s EPS within a year or so.

(Source: Microsoft Earnings Presentation)

Meanwhile, the company continues to make great inroads with switching its corporate Windows clients to its Office 365 commercial subscription service. Microsoft has consistently been growing its commercial 365 subscriber base by about 30% for the last two years. Today, the company has 135 million commercial Office 365 users, which represents roughly 12% of its installed global user base. This indicates that Microsoft’s fast growth in commercial productivity services should continue for the foreseeable future.

(Source: Microsoft Earnings Presentation)

Even Microsoft’s legacy and hardware businesses are doing well. While Windows OEM consumer sales are down slightly, that’s to be expected as global PC sales are in secular decline. More importantly, its professional Windows sales are growing at double digits. Meanwhile, its non core businesses, like Surface, Xbox live, gaming, and search (Bing) revenue are all showing double-digit sales growth.

  • Search revenue: 17% growth
  • Surface revenue: 25% growth
  • Xbox Live subscription revenue: 36% growth
  • Gaming hardware: 39%

And like with its other operating units, Personal Computing is also seeking margin expansion as operating profit rose 38%, more than double the division’s 17% revenue growth.

But wait, it gets better! Not just is Microsoft managing to grow its top line at double digits off an enormous base ($110 billion TTM revenue), but that growth is expected to accelerate.

Q1 2019 Guidance

Metric

Midrange Guidance

YOY Growth

Revenue

$27.7 billion

25%

Operating Income

$8.85 billion

58%

(Source: management guidance)

For the next quarter, management is guiding for even more impressive growth of 25% in revenue and a stunning 58% growth in operating income. The bottom line is that Microsoft is once more a revenue and profit growth machine. And thanks to its strong long-term growth runway, that is likely to continue for the foreseeable future.

2. Long-Term Growth Potential Is Excellent

Analyst firm Research & Markets expects cloud computing to grow at about 27.5% CAGR between 2017 and 2025, when it will become a $1.25 trillion global market. Now granted this is for every part of the cloud industry, which includes markets that Microsoft isn’t targeting. But given that Microsoft’s cloud business generated just $23 billion in the past year, this shows that Microsoft’s growth runway in cloud is long and vast.

The key to its cloud strategy is incorporating ever more useful applications, including those driven by AI data analytics. These allow companies to not just store their data in Microsoft’s cloud, but make sense of it, including how to optimize operations to boost profitability. For instance, Dynamics 365, Microsoft AI driven data analysis suite, saw 61% revenue growth indicating that the company’s corporate clients are loving its new offerings. Meanwhile, the company’s computer engineers added 500 new capabilities to its Azure cloud platform over the past year, which explains why its red hot growth rate continues.

According to analyst firm Synergy Research, in Q2 2018, the cloud computing market grew 50%. That’s compared to 44% for the full year 2017 and 50% in 2016. The industry’s top five players (Amazon, Microsoft, IBM (NYSE:IBM), Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and Alibaba (NYSE:BABA)) control 75% of the market and continue to tighten their grip.

More importantly, according to Synergy, only four of the world’s 25 largest cloud providers saw any growth in market share (Amazon, Google, Alibaba, and Microsoft). IBM’s market share remained flat at 8% and everyone else lost ground.

According to John Dinsdale, Chief Strategist at Synergy:

In a large and strategically vital market that is growing at exceptional rates, they (industry leaders) are throwing the gauntlet down to their smaller competitors by continuing to invest enormous amounts in their data center infrastructure and operations. Their increased market share is clear evidence that their strategies are working.”

In other words, in cloud computing, moats are getting wider, thanks to the importance of AI driven data analytics. The more users a company can attract to train its AI algorithms to analyze data better, the more of an edge its service suite will gain. This shows that cloud computing has a very large network effect, in which winners tend to keep on winning.

Analyst firm Gartner thinks that the industry’s top two players (Microsoft and Amazon) might end up controlling 90% of the cloud market by 2020. Personally, I think that Alphabet and Alibaba’s strong cloud growth rates make this unlikely. But Microsoft’s market share is still likely to grow modestly over time. Combined with the torrid growth rate of the global cloud market that should easily allow its intelligent cloud business to keep up its rapid growth rate for at least the next decade, and likely far beyond.

Part of Microsoft’s strategy to dominate the cloud/AI analytics is by an increasing focus on developers. This is why it recently bought GitHub for $7.5 billion in an all stock deal. Now, long-time Microsoft investors might be leery of the company making large scale purchases, given the terrible track record it had with those in the Ballmer years. But the thing to remember about Nadella’s Microsoft is that its big M&A deals are far more focused and represent good strategic fits for Microsoft’s cloud/software as a service business model.

For example, here’s what Nadella said when announcing the GitHub acquisition.

“According to LinkedIn data, software engineering roles in industries outside of tech such as retail, healthcare, and energy are seeing double-digit growth year over year, 25 percent faster than the growth of developer roles in the tech industry itself…As every company becomes a digital company, value creation and growth across every industry will increasingly be determined by the choices developers make.”

This highlights the strategic reason Microsoft wants to own GitHub, which is basically the Facebook (FB) for software developers. That’s because it’s the world’s leading software application design platform with 28 million developers and 85 million applications in its repository. Now, it’s important to realize that GitHub is open source, so Microsoft isn’t likely to get much proprietary software from this deal. But the brilliance of the acquisition is that Microsoft wants GitHub developers to use Azure as their primary development platform. In other words, Microsoft wants GitHub app developers to become the Android of software application development, and for Azure to be the backbone infrastructure on which they operate.

This is a brilliant move that other companies like Apple (AAPL) and Alphabet have adopted with their own ecosystems. They crowdsource innovation from millions of developers all over the world rather than try to design everything in house. And just like Facebook bought Instagram and Snapchat to build its own social media empire, Microsoft is strengthening its own moat by adding LinkedIn (world’s biggest professional social network) and GitHub (world’s biggest developer network) to app driven cloud empire.

Now, it should be noted that GitHub isn’t going to move the needle for Microsoft financially. That’s because the rapidly growing company’s revenues will be a drop in the bucket compared to Microsoft’s $110 billion in sales.

  • GitHub 2015 revenue: $95 million
  • GitHub 2016 revenue: $200 million

But the point of this acquisition was to further strengthen Microsoft’s cloud platform, which is ultimately the heart of the stock’s long-term investment thesis. But part of that thesis resides in management itself, including Nadella’s brilliant execution so far.

3. World Class Management Team With Proven Execution Ability

Satya Nadella has been with Microsoft for over 20 years and was the head of its cloud computing division before taking over the top spot four years ago. Nadella’s willingness to refocus the company’s business model on cloud has proven a major success. A major reason he’s been able to restore the company to strong growth is his adaptability.

As CEO Satya Nadella told analysts at this quarter’s conference call:

We reorganized our engineering teams to break free of the categories of the past and better align with the emerging tech stack from silicon to AI to experiences, to better serve the needs of our customers today and long into the future. We reoriented our sales and marketing teams, adding industry and technical expertise to partner more deeply with our customers on their digital transformation journeys.” – Satya Nadella

Basically, under Nadella, Microsoft has once become a highly customer-oriented company, the opposite of the Ballmer years. As a result, Microsoft’s business units have not just seen strong growth, but more importantly, the company’s profitability has greatly improved.

Company

Gross Margins

Operating Margin

Net Margin

FCF Margin

Return On Invested Capital

Microsoft

67.6%

34.5%

29.5%

29.2%

139.9%

Industry Average

49.9%

5.1%

3.8%

NA

10.3%

(Source: Morningstar, Gurufocus, CSImarketing)

In tech, many companies battle to win market share by undercutting rivals on price. Microsoft’s focus on creating one of the world’s most advanced and useful cloud/data analytics platforms allows it to grow strongly while retaining exceptional profitability. For example, its net margins are about 650% above the industry norm, and its most recent return on invested capital was a staggering 140%. This indicates management is allocating shareholder capital with incredible discipline and more skillfully than almost any company in the world. Then, of course, there’s the company’s impressive free cash flow margin.

Free cash flow is the most important metric for dividend investors to focus on. That’s because FCF is what’s left over after running the company and investing in future growth. In the past year, Microsoft converted almost 30% of revenue into FCF ($32.3 billion). This means that even after paying its $12.7 billion dividend, the company had $19.6 billion left over to spend on buybacks, acquisitions, or add to its $134 billion cash pile.

And keep in mind that all this impressive profitably isn’t coming at the expense of investing for the future. Microsoft’s R&D spending, mostly into cloud and AI driven data analytics, has been exploding in the last two years.

Chart

MSFT Research and Development Expense (TTM) data by YChartsChart

MSFT R&D to Revenue (TTM) data by YCharts

Today, Microsoft’s R&D/revenue margin is the second highest of the world’s top five cloud computing companies. This bodes well for the company’s ability to retain its edge and continue generating strong top and bottom line growth in the coming years.

In fact, analysts currently expect Microsoft to enjoy low double digit sales growth over the next decade, mostly driven by its strong commercial and cloud businesses. Combined with slightly increased margins and steady buybacks, that’s expected to generate about 14% EPS growth. For a tech giant of Microsoft’s scale, that is a very impressive growth rate indeed. It also sets the company up to become a strong market beater in the coming years.

4. Dividend Profile: Super Safe Dividend, Fast Growth And Market Crushing Return Potential

The most important aspect to any income investment, and what ultimately drives total returns over time, is the dividend profile. This consists of three parts: yield, dividend safety and long-term payout growth potential.

Company

Forward Yield

TTM FCF Payout Ratio

Projected 10 Year Dividend Growth

10 Year Potential Annual Total Return

Valuation Adjusted Total Return Potential

Microsoft

1.6%

39%

14.0%

15.6%

16.2%

S&P 500

1.8%

38%

6.2%

8.0%

2% to 5%

(Source: Morningstar, Gurufocus, Gordon Dividend Growth Model, FastGraphs, BlackRock, Vanguard, Simply Safe Dividends, Yardeni Research, Multpl.com)

Now, it is true that Microsoft’s yield is paltry, lower than even the pitiful payout of the S&P 500. However, what it lacks in current income, Microsoft more than makes up for in bank vault like dividend safety and strong long-term growth potential. That’s because its trailing FCF payout ratio is just 39%, indicating that its massive and growing stream of subscription based cash flow is more than enough to cover the dividend. And then, there’s the fortress like balance sheet to consider.

In the M&A and capex-heavy tech sector, a strong balance sheet is essential.

Company

Debt/EBITDA

EBITDA/Interest

Current Ratio

S&P Credit Rating

Average Interest Rate

Microsoft

1.5

18.1

2.9

AAA

3.6%

Industry Average

1.3

26.5

1.9

NA

NA

(Sources: Morningstar, Gurufocus, FastGraphs)

Microsoft is one of just two companies with a AAA credit rating (the other is Johnson & Johnson (NYSE:JNJ)), which is a higher rating than the US Treasury. That’s thanks to very manageable debt levels, supported by a massive stream of recurring and stable cash flow.

In fact, Microsoft, like many large tech blue chips, actually has a net cash position. In Microsoft’s case, cash exceeds total debt by $57.5 billion. And given that its retained FCF (free cash flow minus dividends) is nearly $20 billion per year, to say the company’s balance sheet is safe would be an understatement.

What about its dividend growth potential? Well, currently, analysts expect Microsoft to grow its EPS by 14% over the next 10 years. While all such forecasts need to be taken with a healthy grain of salt, in this case, I think that is a reasonable projection. That’s because Microsoft’s twin growth catalysts of its fast growing cloud and ongoing rapid transition of commercial Office users to Office 365 should easily allow for double digit top and bottom line growth. And as we’ve seen over the past few years, Microsoft is not sacrificing margin to win market share.

Assuming that FCF/share grows in line with EPS and Microsoft maintains a relatively stable payout ratio, this means that it should be able to grow its dividend by about 14% CAGR for the next 10 years as well. For context, that would mean approximately quadrupling the payout by 2028, meaning a yield on today’s cost of about 6.4%.

Now, historically (since 1956), dividend stocks have generally followed the rule that total returns equal yield + dividend growth. That’s called the Gordon Dividend Growth Model or GDGM. As long as a company’s business model is stable over time, and it starts out at fair value, then this formula is usually a good approximation of long-term total return potential. So assuming Microsoft experiences no major changes in its valuation metric, it should easily be capable of 15% total returns over the next decade. That’s in contrast to the 8% return the GDGM estimates for the S&P 500.

But when we consider starting valuations for both Microsoft and the S&P 500, then we see that Microsoft could actually generate about three times the returns of the broader market. That’s because Morningstar, BlackRock and Vanguard estimate from today’s valuations the S&P 500 is likely to return just 5% (or less) annually over the next five to 10 years.

In contrast, Microsoft’s valuation adjusted total return potential is about 16%. How do I get to that estimate? Well, that’s where Microsoft’s valuation comes in.

5. Valuation: Still Potentially 6% Undervalued Making It A Buy Today

Chart

MSFT Total Return Price data by YCharts

Over the past 12 months, Microsoft shares have been on fire, crushing not just the S&P 500 but also the tech heavy Nasdaq. So, naturally, many investors might worry that Microsoft is currently grossly overvalued. Fortunately, I think it’s actually about 6% undervalued.

Now, it should be noted that there are numerous ways to value a stock, and none are 100% objectively correct. This is why I typically use several time tested methods in concert to ensure that no single approach provides a false valuation picture.

One approach is to compare the PE ratio to its historical PE ratio. Over time, PE ratios (like most valuation metrics) tend to mean revert, unless the company’s business model goes into permanent decline. Due to the permanent earnings boost from tax cuts this year, I’m using the forward PE ratio to get a clearer picture of relative valuations.

Currently, Microsoft’s forward PE is 25.2, which is much higher than the S&P 500’s 16.6. So, that means it’s overvalued right? Well, actually over the past 20 years (including the stagnant Ballmer years), MSFT’s average PE was 29.6. This implies it might be 15% undervalued today.

But 25.2 is still a pretty high multiple, so the question is how reasonable is that given the company’s strong long-term growth prospects? To answer that, I use a Fair Value PE formula devised by Benjamin Graham, Buffett’s mentor and the father of modern value investing. That formula is: (8.5 + (2X long-term EPS growth rate))/discount rate. The discount rate (decimal form) is your desired long-term rate of return. For these calculations, I use 10% because that’s better than the market’s historical (since 1871) 9.2% CAGR.

Forward PE

Historical PE

Implied 10 Year EPS Growth Rate

Graham Fair Value PE

Graham Fair Value

Discount To Fair Value

25.2

29.6

8.4%

33.2

$142

32%

(Sources: Gurufocus, Benjamin Graham, FastGraphs)

The Graham Fair Value formula can tell us two things. First, that Microsoft’s current shares are baking in about 8.4% long-term EPS growth. That’s far below what its currently growing at and what analysts expect it to achieve over the long term. In fact, assuming Microsoft can indeed growth EPS at 14% over the next 10 years (I think it can) then according to Graham a fair value PE and price would be 33.2 and $142, respectively. That implies shares might be as much as 32% undervalued.

However, there is indeed a time tested valuation method that does show Microsoft as highly overvalued. This is an approach that has worked well since 1966, developed by Investment Quality Trends or IQT. IQT has been beating the market for over 32 years (that’s as far back as the publicly tracked model portfolio goes) by comparing yields to their historical yields. The reason this works is that, assuming the business model doesn’t collapse, a dividend stock’s yield tends to be mean reverting over time. This means it cycles around a relatively fixed point that approximates fair value. IQT has been running its asset management business for 52 years purely based on buying blue chip dividend stocks when yields are much higher than historical norms (undervalued), and selling when they are far beneath them (overvalued).

Yield

5 Year Average Yield

13 Year Median Yield

Discount To Fair Value

1.6%

2.6%

2.3%

-35%

(Sources: Gurufocus, Simply Safe Dividends)

In the case of Microsoft, we can see that the five year average yield and 13-year median yield are indeed similar. And so, under this time tested valuation model, Microsoft’s 1.6% yield appears to indicate it might be 35% overvalued. However, note that Microsoft is set to hike its dividend in the next quarter, so that overvaluation could drop substantially, depending on the magnitude of the hike. Given its strong results, the company could easily increase the dividend 15% to 20%, which would drastically lower this frightening overvaluation figure.

One final approach I use is a three stage discounted cash flow or DCF model, such as provided by Morningstar. A DCF model estimates a stock’s intrinsic value purely based on the net present value of all future cash flow (extending out to infinity). Theoretically, this is the purest form of valuation. Unfortunately, because it uses so many assumptions (including long-term smoothed out growth rates over decades) and requires a discount rate that’s different for everyone, it shouldn’t be used in isolation.

However, as one method among several, it can provide some insight. That’s especially true for Morningstar’s 100% long-term focused analysts who are usually some of the most conservative in their growth assumptions.

Morningstar Fair Value

Discount To Fair Value

$122

11%

(Source: Morningstar)

Morningstar’s DCF model (which I can confirm is conservative) shows Microsoft as 11% undervalued today. Combining this with the other valuation models, I estimate the stock is worth at least $114 today, implying a margin of safety of 6%.

Estimated Fair Value

Discount To Fair Value

Long-Term Valuation Return Boost

$114

6%

0.6%

(Sources: Gurufocus, FastGraphs, Simply Safe Dividends, Benjamin Graham, IQ Trends, Gordon Dividend Growth Model, Morningstar)

Over time, all stocks trade purely off fundamentals. This means that assuming Microsoft reverts to fair value over the next decade investors could expect a 0.6% CAGR return boost from the stock’s current valuation. Thus, the valuation adjusted GDGM estimate of its long-term potential total return is: 1.6% yield + 14% dividend growth (proxy for EPS and FCF growth) + 0.6% valuation boost = 16.2%. Historically, this formula has been about 80% to 90% accurate, which means that Microsoft very likely has strong market beating return potential.

Under the Buffett principle that “it’s better to buy a wonderful company at a fair price than a fair company at a wonderful price”, I generally feel comfortable recommending Grade A blue chips at fair value or better. This means that Microsoft is still a buy today, at least for long-term investors comfortable with its risk profile.

Risks To Consider

Microsoft is certainly a low risk blue chip, but there are nonetheless some challenges it will face in the coming years.

(Source: Microsoft Earnings Presentation)

A short to medium-term risk is currency fluctuation. As a giant multinational, Microsoft does business all over the world. Thus, fluctuations in the value of the US dollar relative to other currencies can have a substantial impact on its sales, earnings, and cash flow. As you can see above this quarter currency fluctuations helped boost its growth rates. But the US dollar is now strengthening, which means that foreign sales could soon translate into less US dollars and create a negative growth headwind. That’s because US interest rates are either rising (short-term rates) or flat (long-term) but much higher than in the UK, EU, and Japan. Thus, dollar-denominated assets are becoming more attractive and foreign capital is flowing into them, increasing relative demand for dollars. Fortunately, over time, currency fluctuations tend to cancel out, meaning that this is not a long-term threat to the company’s investment thesis.

But Microsoft does have some long-term fundamental risks to be aware of. The first is the effects of more aggressive capex spending on its all important FCF. Free cash flow fell by 15% in the latest quarter and on a TTM basis only grew 3% due to heavier investment into the company’s cloud business. The good news is that operating cash flow grew 13% and a major part of this quarter’s weakness was one time tax charges related to the new accounting rules (ASC 606) that recently went into effect in the US.

But the point is that investors will want to watch Microsoft’s FCF conversion ratio going forward. Specifically, that its FCF/share will be growing roughly in line with its earnings. Remember that earnings is for accounting, but FCF is for paying dividends. FCF is operating cash flow minus capex (including R&D) and so if Microsoft continues ramping up its capex cloud spending too quickly, it may result in FCF/share growth being far more tepid than its impressive EPS figures. That might result in slower than expected dividend growth, which is ultimately what I and income investors care about.

However, at the same time, we can’t forget that Microsoft is going to have to stay on its toes, because the world of cloud computing is full of hungry rivals who are gunning to dominate this incredibly profitable and fast growing industry. This is why investors need to trust Nadella to allocate capital well. That means investing R&D effectively and in a disciplined fashion. It also means making smart strategic acquisitions.

Acquisitions like LinkedIn and GitHub represent major execution risk in the M&A happy tech sector. The prices Microsoft paid for both companies is rich and only time will tell whether or not these prove accretive to EPS and FCF/share. Now, it should be pointed out that both LinkedIn and GitHub seem like sensible additions to Microsoft’ core offerings and fit well with its cloud/data analytics platforms.

In other words, Nadella is not Ballmer, happily making flashy mega deals in an effort to empire build and in the process lighting shareholder cash on fire. Still investors need to remember that even the best management teams can occasionally misstep. So, as the battle between Amazon, Alphabet and Microsoft heats up, Nadella might be tempted to overpay for a deal that ends up not working out.

Bottom Line: Microsoft Is One Of The Best Technology Dividend Growth Stocks You Can Buy

Don’t get me wrong, after a 50% rally over the last year, I fully understand why many value focused income investors might be leery of buying Microsoft right now. However, the fact remains that the company’s fundamentals are as strong as ever thanks to wide moats in both its legacy Windows and fast growing cloud computing business.

And under the excellent leadership of Satya Nadella, a proven master at cloud computing, I think Microsoft is poised to become one of the most dominant names in cloud and AI. Those are two of the most important tech industries of the coming century and thus represent both massive and very long growth runways.

Which is why I consider Microsoft to be one of the best tech dividend growth stocks you can buy today. Because despite that 50% rally, I think shares are still likely 6% undervalued. And for a world class blue chip like this, I have no qualms about recommending long-term investors buy at even such a modest discount to fair value.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

My Oh My, Another Strong Buy

In a Forbes article last year, I explained that “over the past three decades, corporations have been increasingly executing sale/leaseback transactions – usually to better allocate capital, but also in many cases to manage residual real estate risk.”

Remember that in a sale/leaseback transaction, the owner-occupant of a commercial property sells the asset it owns and occupies by executing a long-term lease with a real estate investor. This structured financing alternative has evolved into an attractive strategy for many corporations to unlock the value of their real estate assets.

Many corporations earn a higher return on their core business as compared to investing their capital in owned real estate. This off-balance sheet alternative provides the occupier 100% of the value of the property compared to traditional mortgage financing, which is usually around 65% loan-to-value.

In the same Forbes article, I explained that “the spigot of capital flowing into corporate machinery and equipment will serve as a catalyst for the Net Lease REIT consolidators that have the strongest management teams and lowest weighted average cost of capital.”

Current economic indicators are very favorable for the U.S. industrial real estate sector due to (1) rising GDP, (2) rampant e-commerce growth, (3) limited new construction since 2010, and (4) manufacturing growth.

The entire retail industry has been shifting its focus from traditional brick-and-mortar stores to e-commerce platforms which has led to significant demand for large, modern industrial distribution centers. In the U.S., e-commerce sales are expected to increase to over $500 billion in 2018. Excluding food, fuel, and auto, e-commerce represents approximately 16% of total U.S. retail sales.

Global consumer habits continue to change resulting in ever greater market share taking place online. Global e-commerce sales are expected to rise to $2.4 trillion this year.

Morningstar Credit Ratings, a subsidiary of Morningstar, Inc., assessed the industrial sector in “an expansionary mode,” well-positioned, reporting, “Trends driving strong demand for warehouse space-primarily the growth of e-commerce and an expanding manufacturing sector-continue to drive low availability of space and encourage developers to build more.

Their Chartbook report suggested with strong demand and low vacancies, industrial REITs in the first quarter easily increased rental rates. And while primary threats to these positive trends are a drop off in manufacturing activity (if escalating tariffs led to an outright trade war), or deceleration in e-commerce trends (very unlikely), the silver lining is: during the downside of previous cycles, the industrial sector “can turn off the new supply spigot relatively quickly, allowing supply and demand to more rapidly return to equilibrium.”

In a REIT.com article, Charles Keenan explains, “there is no doubt that one of the trends that has had the biggest impact on the real estate industry over the past decade has been the growth in e-commerce. While the rise in online shopping has clearly posed challenges for many retail real estate owners and tenants, it has been an absolute boon for other sectors-including industrial REITs.

Photo Source

Monmouth Real Estate: An Overview

Monmouth Real Estate (MNR) is just a few years older than FedEx (NYSE:FDX) (Monmouth is in its 49th year as a public REIT), and the Industrial-sector REIT has also enjoyed a long-standing real estate relationship with the global shipping giant.

Monmouth operates a property portfolio that consists of 109 industrial properties, representing approximately 20.5 million square feet. The geographically diversified portfolio is from coast to coast across 30 states.

The portfolio is highly concentrated with FedEx; the remaining portfolio is balanced with high-quality tenants such as Siemens (OTCPK:SIEGY), Anheuser-Busch (NYSE:BUD), Caterpillar (NYSE:CAT), Coca-Cola (NYSE:KO), Kellogg (NYSE:K), Sherwin-Williams (NYSE:SHW), United Technologies (NYSE:UTX), Cracker Barrel (NASDAQ:CBRL), and others.

MNR began investing in properties leased to FedEx in 1992, and recent acquisitions include six properties consisting of an additional 1.8 million square feet leased to FedEx. Fourteen total expansion projects were recently completed, increasing the rent and lease terms of these FedEx facilities. FDX and its subsidiaries represent 55.5% of annual rent and 46.0% based on square footage.

Monmouth leases from FedEx Ground, FedEx Express, and FedEx Supply Chain Services – all unique operating subsidiaries that enjoy the parent S&P rating of BBB. On the Q4-18 earnings call, FedEx’s EVP, Raj Subramaniam commented:

The economic outlook remains very favorable. The U.S. industrial sector has shifted into higher gear and capital spending is expanding. Consumers are benefiting from a strong labor market and tax cuts are supporting incomes.

Overall sentiment remains near multi-year highs. Globally, the structured three-speed world is becoming visible again after a couple of years of synchronous global growth. While the U.S. accelerates, the Eurozone and Japan are slowing and the emerging world continues to post the fastest rates of growth.

On balance, we expect another year of strong global growth as economic momentum runs through a healthy pace. Sound fundamentals remain in place to underpin sustained growth in global manufacturing and business investment.”

Photo Source

As you can see below, MNR also has substantial exposure to the East Coast, and that’s another important characteristic since the company should benefit from the Panama Canal expansion that was completed in the first half of 2016.

Each of MNR’s FedEx locations has become a highly coveted foothold for large businesses. Major retailers are drawn to FedEx locations, so they can get their goods delivered to their customers as fast as possible.

MNR’s FedEx Ground locations have become the nucleus of today’s logistics clusters. The company has focused investments on assets that are mission-critical to its strong tenant base.

Note that the leases are well-balanced, so there is no fear of expirations that could impact MNR’s reliable rental income. Monmouth’s average lease maturity as of the latest quarter increased to 7.8 years and the average annual rent per square foot is $5.89.

During the latest quarter, Monmouth acquired two brand-new Class A built-to-suit facilities. These acquisitions contain a total of approximately 762,000 square feet and represent an aggregate cost of $64 million.

One of these acquisitions is leased to B. Braun Medical for 10 years and the other facility is leased to Amazon (NASDAQ:AMZN) for 11 years. From a run rate standpoint, Monmouth expects these two properties to generate a combined total annual rent of approximately $4.2 million, representing an initial unlevered return of 6.6%.

Photo Source

Monmouth financed both of these properties with two fixed-rate mortgages totaling $38.5 million with a weighted average interest rate of 4.2% and a weighted average debt maturity of 14.5 years. The B. Braun Medical facility located in Daytona Beach, Florida, near the tenant’s new manufacturing facility and is in close proximity to the Daytona Beach International Airport and Interstate 4.

The Amazon acquisition is located in Mobile, Alabama, and represents Monmouth’s second property leased to Amazon. The Port of Mobile has been experiencing substantial demand as a result of the recently completed Panama Canal expansion. With two interstate highway systems and five Class-1 railroads serving the port, this region is very well situated to benefit from meaningful long-term growth.

Photo Source

Thus far in fiscal 2018, Monmouth has acquired five buildings for a total purchase price of $174 million. Through the first three quarters, Monmouth has generated 9% growth in gross leasable area and a 15% increase over the prior-year period.

Additionally, during the quarter, Monmouth sold two properties totaling 156,000 square feet for net proceeds of approximately $11.6 million, resulting in a net realized gain of $2.1 million.

The Balance Sheet

Monmouth’s acquisition pipeline contains 1.1 million square feet, representing $221.4 million, comprised of four acquisitions scheduled to close over the next several quarters.

To take advantage of today’s attractive interest rate environment, Monmouth has already locked in very favorable financing for all four acquisitions. The combined financing terms for these four acquisitions consists of $142.1 million in proceeds, representing 64% of total cost, with the weighted average interest rate of 4.1%.

Each of the four financings are 15-year, self-amortizing loans and these acquisitions will result in a weighted average loans return on equity of approximately 13%.

Thus far during fiscal 2018, Monmouth has fully repaid four mortgage loans, totaling approximately $8.6 million with fixed interest rates ranging from 5.2% to 6.8% associated with these properties. These newly unencumbered properties generate over $2.6 million in net operating income annually.

As of the end of the quarter, Monmouth’s capital structure consisted of approximately $815 million in debt of which $657 million was property level fixed-rate mortgage debt and $158 million were loans payable.

Around 81% of total debt is fixed rate, with the weighted average interest rate of 4.1% as compared to 4.2% in the prior-year period. Monmouth also had a total of $277 million in perpetual preferred equity at quarter-end. Combined with an equity market capitalization of $1.3 billion, the company’s total market capitalization was approximately $2.4 billion at quarter-end.

From a credit standpoint, Monmouth continues to be conservatively capitalized, with net debt to total market capitalization at 33%, and net debt plus preferred equity to total market capitalization at 45% at quarter-end.

In addition, Monmouth’s net debt less securities to total market capitalization was 26% and net debt less securities plus preferred equity to total market capitalization was 38% at quarter-end.

For the three months ended June 30, 2018, Monmouth’s fixed charge coverage was 2.4x, and net debt to EBITDA was 6.6x. The ratio of net debt less the REIT securities portfolio to EBITDA was 5.2x.

From a liquidity standpoint, Monmouth ended the quarter with $6.9 million in cash and cash equivalents and held $167.6 million in marketable REIT securities with $8.4 million in unrealized losses.

At quarter-end, Monmouth’s $167.6 million REIT securities portfolio represented 9.2% of undepreciated assets. Additionally, the company had $90 million available from the credit facility as of the quarter-end, as well as an additional $100 million potentially available from the accordion feature.

The Latest Earnings Results

Monmouth’s core funds from operations for Q3-18 were $18 million, or $0.23 per diluted share. This compares the core FFO for the same period one-year ago of $15.4 million or $0.21 per diluted share, representing an increase of 10%.

Adjusted funds from operations (or AFFO, which excludes security gains or losses) was $0.22 per diluted share for the recent quarter, representing an increase of 16% over the prior-year period.

Rental and reimbursement revenues for the quarter were $36.2 million, compared to $28.6 million, or an increase of 27% from the prior year. Net operating income increased $4.8 million to $28.8 million for the quarter, reflecting a 20% increase from the comparable period a year ago.

This increase was due to the additional income related to the 10 properties purchased during fiscal 2017, and the 5 properties purchased during the first three quarters of fiscal 2018.

Monmouth’s end of period occupancy decreased 20 basis points from 99.8% in the prior-year period to 99.6% at quarter-end, and was up 40 basis points sequentially. As referenced above, the weighted average lease maturity as of the quarter-end was 7.8 years, which remained unchanged from the prior-year period.

With regards to Monmouth’s same property metrics for the current nine-month period, the same property occupancy decreased 30 basis points from 99.8% to 99.5%, while same property NOI remained relatively unchanged.

Monmouth has maintained or increased its common stock dividend for 26 consecutive years, and also increased AFFO per share by 16% over the prior-year quarter and by 18% year over year for the nine-month period.

As Monmouth’s CEO, Mike Landy points out:

“With a very conservative 77% AFFO dividend payout ratio this quarter, we remain confident about continuing to provide our shareholders with the high-quality, reliable income streams we have delivered for over a quarter century. This quarter represented our 10th consecutive quarter with an occupancy rate above 99%.”

The Key Differentiator

It’s important to understand that while Monmouth is considered an Industrial REIT, the company has longer lease terms than many of the peers. Most industrial leases are 5 years (with options to extend), but Monmouth invests in newer buildings that were build-to-suit for companies like Amazon and FedEx.

These newer buildings make Monmouth more like a Net Lease REIT than an Industrial REIT, and this means there is less cap-ex and releasing costs (compared to the industrial REIT peers).

So there is value in Monmouth’s highly predictable cash flows that are less influenced by tenant rollover and retention risk. Now consider Monmouth’s attractive dividend history:

As you will see, Monmouth has not excelled at dividend growth, up until recently. However, it’s important to note that the company has never cut its dividend.

Now let’s compare Monmouth’s dividend yield with the peer group:

Considering Monmouth’s growing portfolio of high-quality properties, I consider the dividend yield attractive. Remember that the payout ratio is now 77% (based on AFFO) that provides a nice cushion and attractive margin of safety supporting continued acceleration of dividend growth. Now consider the P/FFO multiple:

As you can see, many of the Industrial REITs have benefitted from the boom, but Monmouth continues to trail the 4-year P/FFO average. Currently, Monmouth trades at 18.8x, around 4% below the 4-year average.

What about growth?

As you see, Monmouth is forecasted to grow FFO/share by double digits in 2018-2020. There aren’t many REITs that can move the needle by double digits unless you are in the cell tower or data center sector.

Wait… Monmouth is in the e-commerce sector and that’s precisely what is fueling the strong performance.

So why has Mr. Market ignored the catalyst?

I can’t speak for Mr. Market, but I can for myself…

I am upgrading Monmouth from a BUY to a STRONG BUY and including this REIT in my “New Money Portfolio“. Essentially, this means that I believe Monmouth could generate total returns of around 25% per year during 2018 and 2019. For more information on the New Money portfolio, subscribe to The Intelligent REIT Investor or the Forbes Real Estate Investor newsletter.

Note: Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked.

Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).

Sources: F.A.S.T. Graphs and MNR Investor Presentation.

Disclosure: I am/we are long ACC, AVB, BHR, BPY, BRX, BXMT, CCI, CHCT, CIO, CLDT, CONE, CORR, CTRE, CXP, CUBE, DEA, DLR, DOC, EPR, EQIX, ESS, EXR, FRT, GDS, GEO, GMRE, GPT, HASI, HT, HTA, INN, IRET, IRM, JCAP, KIM, KREF, KRG, LADR, LAND, LMRK, LTC, MNR, NNN, NXRT, O, OFC, OHI, OUT, PEB, PEI, PK, PSB, PTTTS, QTS, REG, RHP, ROIC, SBRA, SKT, SPG, SRC, STAG, STOR, TCO, TRTX, UBA, UMH, UNIT, VER, VICI, VNO, VNQ, VTR, WPC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

China’s Didi Chuxing Suspends Carpool Service After Woman Is Killed

Didi Chuxing said it will suspend a carpool service and has removed two executives after a second female customer in three months was allegedly killed by a driver in China.

The ride-hailing app company said in an emailed statement on Sunday that it will halt its Hitch service starting Monday and reevaluate the carpool operation’s business model. Didi has removed Huang Jieli as Hitch’s general manager and Huang Jinhong as vice president for customer services, according to the statement.

A driver in the eastern city of Wenzhou suspected of killing a female passenger on Aug. 24 has been detained, Chinese state media reported. Didi came under intense scrutiny in May, when state media reported a driver used his father’s account to pick up and kill a woman in the central city of Zhengzhou.

Didi apologized for the latest incident and said that it would upgrade its processes for handling complaints. The Hitch service, which the company said handled 1 billion trips over the past three years, was being suspended “because of our disappointing mistakes.”

“Growth of our service scale puts our safety management mechanisms under huge pressure, especially in terms of identifying potential risks, designing effective and efficient processes, and rapid response,” Didi said. “We take to our heart all criticisms from the public and the relevant authorities.”

Officials from China’s ministries of transport and public security said in a statement they met with Didi representatives on Sunday. The government said it ordered the firm to immediately rectify its Hitch service, protect the safety and rights of passengers, and publish the details of any progress it makes. Didi agreed to submit a compliance plan and submit it to the government before Sept. 1, and to add more customer service personnel.

The company said the suspect in the second alleged killing provided full and authentic documentation, and had no criminal record. He passed a facial-recognition test before starting work for the day, Didi said.

Hitch has been marketed as a social ride-sharing service, allowing drivers and passengers to label or rate each other by appearance. Such features have attracted criticism because the platform was rife with comments that marked female passengers as “goddesses” and “beauties.”

Didi said in May it was overhauling safety measures across its business after the first killing. One of the changes would involve the redesign of its emergency help button to display it more prominently on the app interface, it said.

Users of carpooling or similar services should send information including the car’s license plate number and the driver’s name to relatives, the Wenzhou Public Security Bureau said in a statement on its WeChat account.

The 3 Industries Amazon Will Disrupt Next

If you own a business and you expect Amazon.com (NASDAQ: AMZN) to leave you alone, think again. A company that generates over $50 billion in sales in three months, must constantly look for new markets to enter, to maintain the ridiculous growth investors expect. From books, to general merchandise, to cloud services, Amazon’s expansion has already been an incredible run. In the short-term, Amazon Web Services (AWS) is the clear growth driver, with near 50% annual revenue growth. That being said, Amazon is making moves into three different industries and one of these new ventures in particular, could become the next great growth driver for the company.

Trying to secure revenue growth

One of the key changes occurring within Amazon, is the company is moving toward becoming a services company. In the last quarter, 60% of Amazon’s revenue came from product sales, and 40% from service sales. This trend looks to continue, as service sales jumped by more than 59%, whereas product sales increased by just under 29%.

Each of the industries Amazon is moving into focuses primarily on providing services to customers, with product sales being a small piece of the puzzle. The first business Amazon wants to disrupt is a relatively new development. Amazon acquired Ring in April of this year. Selling security systems to do-it-yourself customers is job one. In true Amazon fashion, the company isn’t afraid to undercut its competition to try and take market share.

Company

System Cost

What’s Included

Monthly Cost

ADT

“Installation starts at $199”

You have to call to get a quote (depends heavily on what your needs are)

$36 per month

Ring Alarm Security Kit

$199

Base, keypad, motion sensor, contact sensor

$10 per month or $100 per year

SimpliSafe “The Foundation”

$229

Base, keypad, motion sensor, contact sensor

$15 per month

(Source: Web sites for ADT, Ring, and SimpliSafe)

ADT is a well-known leader in home security. Unfortunately, the company’s monthly plans are far more expensive than either SimpliSafe or Ring. When it comes to self-installation, Ring and SimpliSafe offer similar products, and SimpliSafe says, “97% of our customers set SimpliSafe up themselves.”

The reason Amazon wants in on home security is it fits with the push of Alexa-enabled devices. At $10 a month or $100 a year, this is a cheap way for Amazon to cross-sell security along with other devices and services. The home security market currently is worth about $10 billion. In the next 4-5 years, estimates have the market growing to as much as $50 billion, on the back of self-install options like Ring. If Amazon can capture even 5% of this overall opportunity, at present the company would bring in an additional $500 million in sales. This doesn’t sound like a lot for a company selling billions, but it’s a relatively simple add-on. Over the long-term, monitoring fees would increase the subscription revenue that is driving Amazon forward.

The connection of car to home

It’s no secret that Amazon, Apple, and Alphabet (NASDAQ: GOOG) are battling it out for your smart-home dollar. Apple’s CarPlay and Android Auto have been integrating into vehicles for years, but Amazon isn’t going to let its large cap peers have all the fun.

At present, it seems Android Auto is winning the race for the largest footprint. Alphabet claims that Android Auto works with, “over 500 models.” According to Apple, CarPlay works presently with, “over 400 models.” Since Amazon got a late start in this game, it’s hard to find a hard number of vehicles that work with Alexa. However, if we look at a list of compatible vehicle systems, there are models including high-end vehicles like Lexus, Infinity, BMW, and Mercedes. The non-luxury brands are well represented as well, such as: Ford, Nissan, Toyota, and Fiat Chrysler.

Amazon isn’t just waiting for vehicle manufacturers to allow it into their systems either. There are multiple third-party devices for getting Alexa into your car. One example is the Garmin Speak, which is essentially an Alexa-enabled speaker that sticks to your windshield.

Though much is made of autonomous vehicles, many analysts expect there will be a much larger layer of the market that has smart car capabilities like maps, auto, multimedia streaming, and more, inside of a traditionally controlled vehicle. This “connected car” market is estimated to be worth about $35 billion to as much as $50 billion today. Depending on who you ask, this market could growth to as much as $219 billion in less than ten years.

Using a conservative estimate that Amazon only takes 5% of this market, would imply somewhere in the $2 billion range of additional revenue for the company. Looking less than 10 years out, Amazon could be doing $10 billion or more a year, at just 5% of the connected car business. If Amazon is able to take say 15% to 20%, the company would generate as much in sales from this business by 2025 as it does from all of its product sales today.

$557 billion reasons to crush this market

To even discuss the advertising market, we must at least acknowledge that even Amazon has an uphill road going against the likes of Google and Facebook. In their respective quarters, Google generated over $28 billion in advertising revenue, while Facebook produced about $13 billion. Most investors don’t think of Amazon when it comes to advertising, but that’s exactly my point.

Amazon puts advertising in the “Other” category of its earnings report. This “Other” category generated $2.2 billion in revenue, which doesn’t seem to be too significant when we compare to the duo listed above. However, Amazon isn’t ignoring this business as the category listing might suggest.

In fact, Amazon’s advertising business turned a significant corner late last year. Through the first half of 2017, the advertising business grew significantly by 50% to 60% annually. The latter half of 2017 and moving into 2018, Amazon clearly realized the potential and expanded its offerings.

The company offers sponsored product listings, which were revamped at the beginning of 2018. Each Kindle device gives Amazon a prime (pardon the pun) opportunity, to serve up advertising on the lock screen. In addition, with an estimated 100 million Prime members, there are a lot of eyes on Amazon pages, which makes the site more valuable to traditional advertisers as well.

In the last three quarters, Amazon’s advertising revenue jumped by over 120% or more on an annual basis. At $2.2 billion in revenue, advertising represents about 4% of Amazon’s overall revenue. This business reminds me of the infancy of AWS. Years ago, smart investors were pounding the table about the potential for AWS to Amazon. Advertising has climbed from 2.6% last year to 4% this year. The business is growing at more than double the rate of AWS and is a massive market opportunity.

In 2018 alone, the global advertising market is expected to reach $557 billion. Using our same 5% thesis as before, Amazon’s take would be nearly $28 billion. This would also be a massive shot in the arm for Amazon’s margins as well. At present, Facebook has an operating margin of 44%, and is guiding that this will land somewhere in the mid-30s. Alphabet (aka. Google) carries an operating margin of over 24%. By comparison, Amazon’s operating margin is currently just under 6%.

The bottom line

Analysts are expecting a slowdown in revenue growth for the online giant from 32% annual growth this year to 22% growth next year. If Amazon can capture even 5% of the three industries we’ve talked about, this would add as much as $30 billion to the top line. Admittedly this is an aggressive assumption, but even half of this amount would push Amazon’s revenue growth next year from 22% to 28% annually.

Amazon stock is hard to call cheap, at more than 75 times 2019 projected earnings. However, the company has been crushing analyst estimates, by an average of 48% over the last four quarters. If Amazon can make inroads into home security, connected cars, and advertising, this string should continue. Knowing where Amazon’s next leg of growth comes from, gives long-term investors just another reason to buy the shares.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The Gear That Could Solve the Next Big Wildfire Whodunit

To date, California’s Ranch fire—the (much) larger of the two wildfires that make up the Mendocino Complex fire—has consumed more than 360,000 acres of Northern California, making it the largest conflagration in state history. It was probably wind that taught the nascent Ranch fire to walk and search for food, to glut itself on timber and brush and grass, to race up hills and away from its place of birth. But the crucial details of those beginnings remain unresolved.

Humans start an estimated 84 percent of wildfires, and determining where and how the worst ones originate is a crucial step in assigning blame. That’s where experts like Paul Steensland come in. A wildfire investigator for going on 50 years, he was the US Forest Service’s premier fire sleuth before he retired in 2005 to start his own consultancy. These days Steensland works on a contract basis and trains others to retrace a fire’s path of destruction to its place of origin and sift through the ashes—sometimes literally—in search of its cause.

As another wildfire investigator with 26 years’ experience told me: “Paul is the one. He is the master.” Here, according to him, are the most essential pieces of equipment to bring when analyzing an inferno like California’s Ranch fire.

Camera

Fire investigators show their work. “You need to be able to explain exactly how you narrowed your search from a 10,000 acre area down to the six-inch-by-six-inch square where you found the match,” says Steenland, who is often called on to testify about his findings. Which is why he says a camera is the single most important piece of equipment he brings into the field.

In the case of fires, the primary form of evidence are “indicators”—physical objects carrying traces of an inferno’s spread. A skilled investigator can use them to determine which way a fire was traveling and the direction from which it came, like a hunter backtracking the prints of quarry that just happens to be 1400° Fahrenheit.

An example of foliage freeze in the needles of a pine tree. Fire investigators use indicators like this to map a fire’s spread and retrace its path to its point of origin.

National Wildlife Coordinating Group

So-called “protection indicators” form when part of an object is shielded from the heat of advancing flames. The result is an object with more damage on one of its sides than the other. Another telltale indicator is “foliage freeze.” Like a strand of blow-dried hair, leaves and stems and pine needles can become pliant in the presence of heat and bend in the direction of prevailing winds, only to remain pointed, fingerlike, in the direction of an inferno’s travel as they cool and stiffen. A camera allows investigators like Steensland to catalogue these and other indicators as they map and retrace a fire’s spread.

Color-Coded Surveyor Flags

Fires, in their early stages, tend to burn in a V shape. Leading the charge is what fire investigators call the advancing area. It burns hotter and the more intensely than any other portion of the fire. The apex of the V, also known as the heel, burns slowest and coolest. The flanks, which run outward from the fire’s sides at angles between 45 and 90 degrees, burn at a rate and temperature somewhere in the middle.

Wildfire investigators use color-coded surveyor flags to mark directional fire indicators: Red flags correspond to the advancing area, yellow to the flanks, and blue to the heel. Steensland developed the system in the early aughts as a training tool, but it turned out to be a great way to visualize a fire’s spread on the fly. Now they’re an essential feature of wildfire investigation kits. One by one the flags go up, and pretty soon, generally in the direction of the blue flags near the base of the V, you begin to develop an idea of where the fire began (investigators call this the ignition area), and what it looked like as it moved across the landscape.

Evidence Tents

The yucca base at the center of this photo is an example of a protection fire indicator. It’s been labeled with a red flag, to indicate its presence in an advancing fire area. The yellow evidence tents denote that the indicator was photographed and its positioned measured. The red arrow points in the direction of fire progression at that point.

Paul Steensland

This LIDAR map depicts the indicators that Steensland and his team flagged in the General Origin Area, or GOA, of the Oil Creek Fire a wildfire that burned some 60,000 acres of northeast Wyoming in 2012. The color coding reflects how the fire spread, based on the evidence they found.

Paul Steensland

Investigators scrutinizing a large fire can find on the order of 1,000 indicators. Of those, a team might only mark a couple hundred. “And out of those, we typically only document 30, 40, or 50,” Steensland says.

What indicators they document they’ll mark with evidence tents—little yellow triangles marked with bold, black numbers. The point is to select a representative sampling of the indicators that they found. Documenting all of them would be overkill, but when you’re presenting your evidence to a lay audience—a judge and jury, for example—it’s important to have a good visual examples of what you discovered in the field. “So you can say, yeah, we found and marked 50 charred rocks. We only photographed three of them, but this is what the other 47 looked like,” Steensland says.

100-Foot Steel Tape Measure (x2)

Another purpose of documentation is reproducibility. That means photographs alone are insufficient; to ensure that anyone can visit the scene at a later date, check your work, and retrace your steps, you need to specify precisely where you found each piece of evidence.

Handheld GPS units can be off by more than 20 feet. Not good enough. Instead, Steensland recommends the right angle transect method: Run a 100-foot tape measure along a north-south or east-west axis, between two markers placed somewhere near a cluster of evidence. (Two pieces of rebar, painted orange, usually does the trick.) Then run a second tape measure from each piece of evidence back to the first measuring tape, such that the two tapes overlap at a 90 degree angle. Record the distances and bearings between the point of intersection, your rebar, and the pieces of evidence you’re documenting.

Steensland says GPS units are typically good enough to get someone to your reference points, and might soon become accurate enough to abandon the transect method. But for now, evidence at most fires is still measured and documented with tape.

Stakes and String

A fire investigation team uses stakes and string to perform a grid search.

National Wildlife Coordinating Group

Wildfires are common enough that investigators sometimes evaluate several per day. When you’re working that quickly, there’s no time to be meticulous. “Most fires are small, and there’s never going to be civil collection for damages, so there’s no incentive to determine who’s responsible,” Steensland says.

Stakes and string (A), a magnifying glass (B), and steel measuring tape (C), are just some of the essential fire investigation tools featured in this kit.

Deaton Investigations

But when a fire becomes big, expensive, or deadly, investigators will take time to plot out the suspected ignition area with stakes and string, dividing the ground into parallel lanes no more than a foot wide. When the fire is particularly bad—if multiple people have died, or the investigators suspect arson—they’ll run additional string perpendicular to the search lanes to form a grid, just like an archaeological site. Dividing the ignition area into small squares serves to systematize the search and guide the eye, both of which are crucial for the steps that follow.

Magnifying Glass

The search of the ignition area proceeds in four stages. Stage one involves scouring the ground visually, unaided. For the second stage, investigators make another pass with the help of magnification. To keep his hands free, Steensland uses four-power reading glasses, but many investigators opt for a magnifying glass.

Patience and diligence are key. To quote the Guide to Wildland Fire Origin and Cause Determination, a 337-page field guide published by the National Wildfire Coordinating Group that Steensland helped develop, the cause of the fire is “usually very small, and black, and is located in the middle of a lot of other black material.”

Magnet

After their visual search, investigators proceed to stage three: Passing over the ignition area with a magnet or metal detector. Steensland prefers to use a magnet, as many of the metal objects that start fires are ferrous. Brake-shoe particles. Splinters from a bulldozer’s cleats. Fragments of a spinning saw head. Even the staple from a book of matches. A powerful magnet can attract all of them through several inches of ash and soil (an important consideration, Steensland says, since hot metal tends to burrow).

“Sometimes you find stuff,” Steensland says. “Most of the time you don’t. But by running over the area with a magnet, you can eliminate ferrous sources of ignition.”

Evidence Collection Kit

Trowels and cans for collecting and storing evidence.

Deaton Investigations

Evidence storage containers and tags

Deaton Investigations

Once they’ve scoured the ignition area by eye and by magnet, investigators will proceed to stage four: Collecting debris and sifting it. “If there’s anything in there big enough to start a fire, you’ll typically catch it,” Steensland says. “I once found a match by sifting—just the head and about a quarter inch of stem.”

Investigators will deposit sifted evidence—and any other clues collected up to this point—into a variety of containers, from paper and plastic bags to old film canisters and pill bottles. These are part of an investigator’s evidence collection kit. “Technically that kit contains more than one item, but I’m going to cheat here,” says Steensland, who carries things like nitrile gloves, tweezers, a small trowel for exhuming fragile objects, and evidence tags to label what he finds. It could be as incriminating as a match or as incidental as an empty beer can (“it might have fingerprints,” Steensland says); if it has evidentiary value, an investigator will bag it and tag it, taking care to note what the object is, who collected it, and where and when it was found.

Perhaps one of the investigators working the Ranch fire will bag a tiny match, or a shard of metal, that ignited California’s biggest blaze ever.


More Great WIRED Stories

Best Latte and Cappuccino Machines (2018): Keurig, Mr. Coffee, Nespresso, Breville

A good latte or cappuccino is like a rich milky mug of heaven. They’re simply delicious drinks, and just writing about them makes me want one. Sadly, creating these drinks at home can be a big hassle. Making a barista-worthy espresso is tough enough, but getting the right amount of milk and foam, perfectly heated and combined, is surprisingly daunting.

I’ve always wondered how well machines that make lattes and cappuccinos actually work. A few months ago, I decided to dive headfirst into the world of advanced coffeemaking devices and find out what makes them tick…er…hiss. After a fair amount of research, I spent almost three months testing eight different machines with latte and cappuccino functionality.

Some machines made pure espresso using coffee shop-style portafilters and came with milk canisters for frothing. Others relied on single-use pods with separate foamers. A few even came with legit steam wands and advanced options. Whether you’re a hardcore latte lover or just want something quick, these are the best latte and cappuccino machines we’ve tested.

1. Best Overall

Breville Barista Express ($550)

Breville

At first, the Barista Express seemed too hardcore for me—it’s basically a coffee shop in a box. The built-in pressure-activated conical burr grinder gives you fresh grounds however you like them, and the pressure gauge and options let you adjust the water temperature and shot amount. You have to froth your own milk, and the steam wand makes it easier than the competition, with a handle and the ability to tilt in any direction. It cleans itself and you can get hot water from the machine to brew tea or make an americano.

Because it can do so much, there’s a steep learning curve. The manual is a little dense and it’s hard to know what to do with all of the included accessories, at least to start. There’s a stainless steel milk jug, magnetic tamper, trimming tool, and more. They’re the highest quality accessories any machine came with, and all proved handy in time.

The Barista Express isn’t cheap, and is probably overkill if you already own a burr grinder, but you’d be hard pressed finding a sturdier, more authentic latte and cappuccino machine that doesn’t cost thousands of dollars.

Buy the Barista Express for $550

(Tip: Use the double-walled filters—they deliver better crema—and when heating your milk, try to position your steam wand just below the surface. If you have it right, the milk will spin as it’s heating. Slowly lower the jug to add foam.)

2. Best Latte for Your Dollar

Mr. Coffee Café Barista ($190)

Mr. Coffee

The Café Barista is perfect if you want pure espresso and a machine that mixes the milk for you without much fuss. It’s plastic and lightweight, which means you have to steady the machine with your hand as you twist the portafilter into place, but other than that it makes fairly rich single or double-sized espressos, cappuccinos, and lattes with the push of a button.

The integrated milk container has its pros and cons. You will have to remember to remove and refrigerate it each morning, and clean it every few days or it could clog up—clean-up is easy, thankfully. Milk tends to come out a little foamier I prefer for a latte, and it took me some time to understand what size glasses I needed for each drink (a double latte, for instance, is 15 fl oz, but a double cappuccino is only 10 fl oz). The slide-out booster is nice for smaller glasses.

Buy the Café Barista for $190 from Amazon

($200 from Mr. Coffee or Walmart)

3. Most Convenient, Easiest Cleanup

Keurig K-Café ($180)

Keurig

I love this machine. It’s the best Keurig I’ve used (8/10, WIRED Recommends), and has the best frother of any machine I tested for this guide. Despite the fact that the K-Café doesn’t technically make espresso shots (the K-cup system doesn’t put its grounds under any pressure), it still makes a delicious “espresso style” 2 oz shot that can taste almost as strong, though without the crema that you might desire.

The real magic is the frother. It has three settings—cold, latte, and cappuccino—and froths milk to perfection with the tap of a button. When it’s done, simply pour your milk with the spout on the side. The jug is made of stainless steel, and the plastic spinner comes right off, making cleanup as easy as a quick run under the faucet. It was so simple to use and clean that I sometimes frothed milk with it even when I used other machines to make my espresso. I liked it so much, I didn’t even mind that the spout on the frother was designed for right handed folks. This lefty was happy to adapt.

Buy the K-Café for $180

4. Best For Nespresso Lovers

Delonghi Lattissima One ($324)

DeLonghi

My house has had a Nespresso in it for years. Nespresso doesn’t taste quite as flavorful as a freshly brewed shot from a coffee shop, but it’s fast and does the trick. There are other Nespresso makers with frothers, but Delonghi’s Lattissima One is an elegant little machine with a solid 19 bars of pressure. The milk jug doesn’t hold a lot of milk, but it’s enough for at least two cappuccinos or a latte and a cappuccino. Just fill it, press the latte or cappuccino button, and the machine will do the work for you. The lattes are good, as long as you don’t mind them on the foamy side.

One quirk worth noting is that the steam nozzle tends to send hot milk in all directions. You’ll learn to compensate by angling the spigot but you do have to keep an eye on it.

The design of this model is top-notch. It’s easy to snap the frother jug on or off (there’s even a tiny door that covers the attachment point, if you want to leave the jug off), and cleanup isn’t too bad, though you’ll need to clean and refill it every day or two. Even with the extra maintenance involved, the Lattissima One is an easy upgrade if you wish your Nespresso could also brew a nice capp.

Buy the Lattissima One for $324

5. Jack of All Trades

Ninja Coffee Bar ($170)

Ninja

The Ninja Coffee Bar (CF092) is for those who want a machine that does it all. It can brew a 4 fl oz “specialty concentrated” shot of strong coffee that’s similar to espresso (minus the crema) and it has a built-in milk frothing wand. Sadly, the wand won’t heat your milk, so you’re going to need to microwave it first.

If you also want to make regular coffee in a single-serve mug or a full pot of brew, the Coffee Bar is a good compromise. It can make eight sizes with other options for stronger or iced brews. The coffee filter is very easy to remove and clean out—just a rinse and you’re ready to brew again. The coffee scoop also snaps onto the side, which is handy.

Buy the Coffee Bar for $170 from Target (Best Price) or $200 from Ninja

(The previous model (CF091) is nearly identical and available on Amazon for $162.)

6. Cheap, Simple Espresso

Hamilton Beach Espresso & Cappuccino Maker ($100)

Hamilton

If all you want is a dead simple espresso maker and frothing wand, this Hamilton Beach works well considering its $100 price tag. It has two settings: steam and brew, and performs them both honorably—though there is no way to get fancy and alter the temperature or pressure. You’ll also have to maneuver taller glasses carefully into place under the spout.

The feature that set me over the edge was the easy lever-style lock for the otherwise traditional portafilter. Instead of getting carpal tunnel syndrome desperately trying to twist it in every day, you can pull the handle down to lock it in place. Espresso comes out tasting as rich as you’d expect, with a healthy head of crema thanks to the 15 bars of pump pressure.

Buy the Espresso & Cappuccino Maker for $100

Machines that Didn’t Make the Cut

Keurig K-Latte ($100): The K-Latte is an admirable, affordable little Keurig with a traditional electric frother on it. It can put out a concentrated shot like the K-Café we recommend, but the frother isn’t any better than one you can buy separate, and its nonstick coating sometimes requires a gentle scrub.

Gourmia GCM4000 K-Cup Latte Maker: This Gourmia also uses Keurig K Cups, has an easy interface, and a nice milk frother built-in. Unfortunately, it has some design flaws. The K-Cup drawer often leaves a puddle around your cup, and if you use reusable K-Cups, they could get stuck in it. The milk jug is also difficult to remove and the distance from the milk spout to a normal cup is too far, leading to splashing and spills. You can adjust the cup shelf height, but you have to watch diligently: there’s a chance your cup might slide right off due to the flimsy nature of the shelf.

Questions and Answers

Jeffrey Van Camp

How did you test each machine?

To find the best latte and cappuccino makers, I first researched what was on the market, widely available, and stuck to models under $800. I ended up testing eight different machines for 1-3 months (depending on the model), using different types of coffees, pods, and milks. I tried to live with each machine, to a degree, and use them casually, but also tested the same milk and grounds in each (where possible) to compare milk/froth ratios and taste.

Setup and cleanup were especially important, as was durability. The entire point of a device like these is to save time and energy, and/or produce a drink of higher quality than can be made without it, so we didn’t recommend any products that didn’t produce tasty espresso and save time.

How do you make a good latte or cappuccino?

There are a lot of differing opinions on ratios, but generally a cappuccino is about 1 fl oz espresso shot (or a 2 fl oz double shot), 2 fl oz steamed milk, and 2 fl oz foamed milk, or an even 1:1:1 ratio. A latte is similar but has more milk and less foam. It’s a 1-2 fl oz espresso shot, 6(ish) fl oz of steamed milk, and a bit of foam that mixes with the espresso crema as you pour in the milk. I sometimes use a spoon to hold back the foam until the end. (I have yet to try and make latte art.)

Technically, the machines in this guide that have milk canisters make latte macchiatos because they pour the milk and foam before the espresso shot. In a traditional latte, the coffee comes first. I prefer traditional lattes in my testing. They were creamier and richer, but they were also more work to make (except with the Keurig K-Café).

Other Espresso Necessities

Great Beans: I’m still trying coffee beans. If you haven’t made espresso before, I recommend you use your favorite standard coffee beans. Just make sure they have a fine grind to them and pack them in tight if your machine has a portafilter. At first, I tried a lot of pre-ground popular espresso blends like Lavazza, Gevalia, and Café Bustelo. They were all too dark and bitter for my taste, but you may like them. Right now, I’m enjoying Kicking Horse coffee beans, specifically Three Sisters.

Electric Frother: Even if you don’t use one of these machines, you can add some froth to your espressos or coffee with an electric milk frother. This $33 Secura frother is pretty standard and has a two-year warranty.

Leveler & Tamper: A lot of machines come with a plastic tamper, but out of the units I tested, only the Barista Express had a proper leveler and tamper. I immediately began using it for other machines. You’ll need to double check the size of your portafilter (some are smaller than normal), but this $19 leveler and tamper should help you pack in those espresso baskets.

Stainless Steel Frothing Pitcher: If your latte maker only comes with a steam wand (like the Hamilton Beach machine on this list), you’ll want to invest in a nice frothing jug. This $13 Star Coffee Frothing Pitcher is nice because it has measurement scales on the inside, which is helpful if you want to get the right coffee/milk ratio.

More Great WIRED Stories

When you buy something using the retail links in our stories, we may earn a small affiliate commission. Read more about how this works.