Investing in restaurant stocks? Keep an eye out for this key distinction

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

Toby Bordelon: When reviewing catering companies, one thing you may want to do is compare them to other catering companies. It is 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 want to compare them. You will find that the margins are really different. Restaurants that do both, break that up into separate segments so you can see what’s going on. But franchised restaurants, you get that franchise fee, which seems like a higher markup. All costs associated with operating this restaurant, food, labor, utilities, land and building rent, if any, are all the responsibility of the franchisee. The franchisor or the company does not assume these costs. Their percentage margins seem much better. On a gross basis, of course, they don’t have all that profit for themselves. You look at company-owned stores, all of these costs are on the company’s balance sheet. As a percentage, those margins are going to seem a little lower because they have all those costs to maintain. You can’t really compare company-owned businesses and franchisees, especially on two different businesses, and say, “Oh, this one has higher margins, it’s better than this one.” You have to make this distinction. When you look at restaurants, you have to think carefully, “What is this model? What are they doing? Is it a franchise model or a model business or are they mixed?” Then approach it once you understand this appropriately based on the costs you expect to see or the margins you expect to see. Don’t penalize a restaurant business for low margins if they’re all company owned. Take this into account.

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