Many entrepreneurs and investors dream of opening their first franchise and then building an empire of them while living off the streams of cash flow. This can be a great investment, but it also often requires a significant upfront franchise fee payment to get started as well as other requirements, such as a certain level of net worth.
For example, while the franchise fee to open a Wingstop (WING -0.36%) is fairly low at $10,000 to $20,000, after all other costs to open are considered, the total cost can range from an estimated $347,600 to $759,100. A potential franchisee also needs a net worth of at least $1.2 million and a liquid net worth of at least $600,000. The cost to open a McDonald's (MCD -1.20%) franchise is also over $1 million and requires a significant minimum net worth to get started.
If you don't have that much, there's no need to despair. You can instead build up a nice nest egg with some serious dividend income by investing in a portfolio of stocks with franchise-based business models. As an added bonus, this also takes a lot less sweat equity than actually opening a franchise!
Advantages of a franchise-based business model
The advantages of a franchise-based business model are numerous, which means that the stocks of these companies are often good investments. Because franchisees are paying much of the upfront cost to open a new franchise, franchisors are asset-light and can expand rapidly without as much cost to themselves as they use the franchisee money to expand. Franchisors often enjoy high margins as they have shifted much of the day-to-day and fixed costs to the franchisee. The franchisors get to collect upfront franchise fees and steady, ongoing royalty fees, which is attractive to investors.
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1. Ruth's Hospitality Group
Known for its Ruth's Chris Steakhouses, which serve up sizzling steaks on 500-degree plates, Ruth's Hospitality Group (RUTH) is made up of 73 company-owned restaurants and 74 franchise-owned establishments. The company collects an upfront fee of $150,000 from franchisees and an ongoing 5% royalty fee on revenues plus 1% for advertising.
Ruth's features 23 international locations, all of which are franchised. With 127 total locations, Ruth's management says it sees plenty of room to keep growing its footprint, which should lead to growing franchise fees and royalty payments over time. Shares of the Florida-based company are modestly valued at about 10 times forward earnings and sport a market-beating dividend yield of 3.3%, which will help you to build up the recurring income in your portfolio.
2. Restaurant Brands International
While you may or may not be familiar with the name Restaurant Brands International (QSR -0.73%), you've definitely heard of one of its primary holdings, Burger King. The company also owns Tim Hortons, Popeye's Louisiana Kitchen, and Firehouse Subs. All told, Restaurant Brands International features a whopping 29,100 restaurants in 100 countries. Restaurant Brands International makes money from franchise fees, royalty payments via each of these franchises' revenue payments, and sales at company-owned restaurants.
I like the idea of getting paid recurring royalty payments from a diversified base of over 29,000 restaurants worldwide. The company is aiming for 40,000 restaurants in the future, so these royalty payments should increase over time. Another thing that I like about Restaurant Brands is that in some cases, it also owns the real estate that these franchises operate on, and it thus also generates money from these leases and subleases.
As you would expect from a company with strong recurring revenue, Restaurant Brands International pays out an attractive dividend that currently yields north of 4%.
3. Franchise Group
While we usually associate franchises with restaurants and fast food chains, franchises run the gamut of types of businesses out there. Enter Franchise Group (FRG) -- the Ohio-based conglomerate is building out a mini-empire that houses businesses such as The Vitamin Shoppe, Sylvan Learning Inc., Pet Supplies Plus, and several furniture sellers.
I like the diverse and recession-resistant nature of Franchise Group's portfolio of businesses. People are still going to buy vitamins and supplements even if there is a recession, and pet owners still need to feed and take care of their furry companions even if the economy weakens. Franchise Group is attractively valued at less than six times earnings and pays out a compelling dividend that yields 7.6%.
Franchise Group has been growing its dividend at a fast and furious pace, from $1.00 a share in 2020 to $2.50 per share now. In addition to the generous dividend, Franchise Group also has a sizable share repurchase program in place.
Recently, Franchise Group tried to acquire Kohl's, but was unable to complete the transaction. This may end up being a blessing in disguise as Kohl's has struggled for years, and Franchise Group can now focus on other opportunities instead. I like the fact that as the company acquires more businesses and grows the store count of its existing franchises, the dividend payout has gone up as well, so I view Franchise Group as a strong buy.
Invest in franchise stocks -- a good first step
Opening up a franchise can be a great and worthwhile investment. If you aren't ready to take that step yet, building up a portfolio of franchise stocks is a great way to invest in these businesses and begin earning a lifetime of recurring income from them. It requires a much lower capital commitment to get started and is a lot less work, while also giving you access to the same asset-light, high-margin business models with recurring revenue.
