Investing in Restaurant Stocks? Keep an Eye on This Key Distinction

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Though it’s common to compare companies in the same industry, investors who are looking at the financials for restaurants should be aware of certain differences before making comparisons. In this clip from “3 Minute Stocks Updates” on Motley Fool Live, recorded on July 19, Motley Fool contributor Toby Bordelon shares tips for investors who are analyzing franchise restaurants versus company-owned restaurants.

Toby Bordelon: When you’re looking at restaurant companies, one thing you might want to do is you want to compare them to other restaurant companies. It’s common to compare companies with others in the same industry. With restaurants, what you want to make sure you do, is look at the difference between franchise restaurants and company-owned restaurants, if you’re going to compare those. You’re going to find the margins are really different. Restaurants that do both, break that out into separate segments so you can see what’s going on. But franchise restaurants, you are getting that franchise fee, that seems to be higher margin. All of the costs associated with running that restaurant, the food, the labor, the utilities, the land, and the building rent, if that’s applicable, is all on the franchisee. The franchisor or the company isn’t bearing those costs. Their margins on a percentage basis look a lot better. On a raw base, of course, they don’t have all of that profit for themselves. You look at company-owned stores, all those costs are on the company’s balance sheet. On a percentage basis, those margins are going to look a little weaker because they got all those costs to keep up. You can’t really go compare company-owned and franchised, especially on two different companies, and say, “Oh, this one’s got higher margins, it’s better than this one.” You got to make that distinction. You want to carefully think when you’re looking at restaurants, “What is this model? What are they doing? Are they a franchise model or are they a company on model or are they mixed?” Then, approach it once you’ve figured that out appropriately based on what costs you would expect to see, or what margins you would expect to see. Don’t penalize a restaurant company for low margins if they’re all company-owned. Factor that in there.