What is the Rule of 40?
The Rule of 40 states that a healthy company’s revenue growth rate plus its EBITDA margin should equal or exceed 40%. It was originally developed for SaaS companies but applies broadly to any growth business.
A company growing revenue at 30% with a 15% EBITDA margin scores 45% — above the threshold. A company growing at 5% with a 20% margin scores 25% — below the threshold. The rule captures the idea that fast-growing companies can afford to be less profitable, and highly profitable companies can afford to grow slowly, but doing neither well is a warning sign.
Why it matters for investors
The Rule of 40 balances the tension between growth and profitability. Growth investors often ignore profitability (“they’re investing in growth!”), while value investors often dismiss high-growth companies for lacking earnings. The Rule of 40 provides a single metric that accounts for both.
Companies scoring above 40 are doing something right — either growing rapidly, generating strong profits, or delivering a healthy mix of both. Companies consistently below 40 may be struggling to find product-market fit or operating inefficiently.
How Stock Analyzer scores it
| Score | Rule of 40 | What it means |
|---|---|---|
| A | 40%+ | Excellent balance of growth and profitability |
| B | 30% – 40% | Strong performance |
| C | 20% – 30% | Moderate — room for improvement |
| D | 10% – 20% | Below average |
| E | Below 10% | Weak growth and profitability combined |
What to watch out for
The Rule of 40 is most meaningful for companies with at least $10M+ in annual revenue. Very early-stage companies often have extreme growth rates that distort the calculation. Also, a company could score well by growing at 50% while burning cash heavily — the rule doesn’t penalize unsustainable growth specifically. Pair it with free cash flow metrics for a fuller picture.