I don’t think I heard of the Rule of 40 before, so it was interesting to see it applied to growth stocks:
In a nutshell, you take the annual revenue growth (%) and add the profit margin. If the number is over 40, it passes the screen.
If a company has some combination of decent growth and profit, you pass the screen. If the profit margin is actually a hefty loss, it can undo the effect of even high growth.
Now add some qualitative analysis, such as understanding the source of a loss or the consistency of the growth. Or apply the Rule to screen a list of stocks you’ve already made.
I am a fan of the use of the Rule of 40, and think it should be considered in a ratio with an EV/S ratio, with the margin portion of the R40 calculation being some blended margin that considers free cash flow (FCF) margin strongly (with maybe some more conventional GAAP Net Income factored in too). The revenue growth portion of the calculation is super easy.
Considering an EV/S in conjunction with the Rule of 40 would help eliminate the artifact of Apple appearing to be in not as good shape as those other companies, and would allow a unified valuation methodology.
Unfortunately, too many other things have prevented me being able to validate my hypothesis.
Not-yet-fully-developed Valuation methodology:
Pre-cursor thoughts to the thread linked above: