Rule of 40 shares
The Rule of 40 is a ratio calculated from various ratios to give a first look at a stock.
Rule of 40 Declaration
The Rule of 40 is a ratio that is made up of various key figures and thus provides an initial view of a share. The growth rate (in %) and the profit margin (in %) are added together. If the sum is 40, this indicates a strongly growing and at the same time profitable company.
The Rule of 40 comes from Silicon Valley and is used there as an important indicator for technology companies. It was developed by venture capitalists as a simple way to measure the success of small, fast-growing companies. That's because this rule takes into account the two most important things:
- How fast is the company growing annually ?
- How profitable is the growth ?
The two questions are very important in context, because growth is easy to achieve. Generating that with profitability, however, is somewhat more difficult. An example of this are companies that offer start-up bonuses or welcome gifts. Here you often find high growth, but little chance to turn the whole model into a positive result.
How is the Rule of 40 calculated?
As mentioned above, the Rule of 40 is made up of sales growth and profit margin. Assuming a company has an annual sales growth of 25% and a profit margin of 20%, you get 45% if you add both values. In this case, the value would be above 40% and the company is therefore "attractive" for a closer look.
Many fast growers are already above the 40% with sales growth alone. Good examples are Amazon or Cloudflare. However, for these companies, the profit margin is quite low, which means that in the long run, a way must be found to generate a higher profit margin.