Rule of 40

A growth-plus-profit health check for software firms: revenue growth % plus profit margin % should be at least 40.

Part of the Growth & Capital Returns course · Lesson 5 of 26

Formula

Rule of 40 score = Revenue growth % + Profit margin % ; pass if >= 40

What it is

The Rule of 40 is a rough benchmark used mainly for software and subscription companies. It says a healthy business should have its annual revenue growth rate plus its profit margin sum to 40% or more. It balances the trade-off between growing fast and being profitable.

Why it matters

Fast-growing software firms often run losses to fund growth, so margin alone looks bad. The Rule of 40 lets you reward growth and profit together, so a 50%-growth, -10%-margin firm (40) and a 10%-growth, 30%-margin firm (40) both pass. Falling below 40 is a flag that the growth-versus-profit mix is weakening.

How it's calculated

Add the year-over-year revenue growth rate to a profitability margin, both expressed as percentages; 40 or above passes. The margin used varies (commonly EBITDA margin or free-cash-flow margin), so always confirm which one is being used before comparing companies.

How Quintarthai uses it

Growth and margin inputs for the Rule of 40 appear on a company deep-analysis page (Financials and Statistics tabs), where you can read revenue growth and margins side by side.

Cross-border note. It applies the same way to US and Canadian software names, but compute growth in the company's reporting currency so a currency swing does not distort the growth rate.

FAQ

Which margin should I use in the Rule of 40?

There is no fixed standard. EBITDA margin and free-cash-flow margin are the most common. The key is to use the same margin for every company you compare, or the scores are not comparable.

Does the Rule of 40 work for non-software companies?

It was designed for high-growth software and subscription businesses. For slow-growth, capital-heavy industries like utilities or banks it is not a meaningful benchmark.

See Rule of 40 on a real company

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