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The Rule of 40 is a shorthand way for venture-capital investors to evaluate companies.
These investors are looking for growth potential, so what the Rule of 40 is just revenue growth combined with margins.
“It is a blunt tool,” said Morgan Stanley strategist Edward Stanley. “A high-level screen to homogenize and benchmark thousands of otherwise incomparable businesses.”
A company with 45% revenue growth, and negative 1% margins, would clear the Rule of 40, just as a company with 20% revenue growth and 20% margins would. A high-margin business with little revenue growth probably would not.
The strategists find that the Rule of 40 is a decent barometer for the readiness of a company for an initial public offering. More than 90% of the companies that went public during the SPAC boom of 2021 and 2022 were not able to hold onto Rule of 40 status after being listed — and collectively, those stocks have dropped 60% from their peak.
Stanley and the team went through Nasdaq large-cap companies that have most regularly beaten that hurdle over the last 25 years. They said that’s no indication of the likelihood these companies will continue to surpass those hurdles.
But what they have found is the companies that have most frequently surpassed these hurdles, at least 10 times, have driven 56% out of the outperformance of the Nasdaq , and 124% of the outperformance of the S&P 500
SPX,
since 2018.
Heading the list are biotech Amgen
AMGN,
and product-design-software maker Ansys
ANSS,
which have each beaten the Rule of 40 fourteen times.
Mega-cap tech giants Microsoft
MSFT,
Meta Platforms
META,
Alphabet
GOOGL,
and Apple
AAPL,
also frequently top the Rule of 40, which intuitively makes a lot of sense. Amazon.com
AMZN,
which for years was chided for sacrificing margins, nonetheless has beaten the Rule of 40 five times.
| Company | Total Rule of 40 beats | Rule of 60 beats | Only Rule of 40 |
| Amgen Inc | 14 | 6 | 8 |
| ANSYS Inc | 14 | 6 | 8 |
| Broadcom Inc | 13 | 11 | 2 |
| Copart Inc | 13 | 3 | 10 |
| Fortinet Inc | 13 | 1 | 12 |
| Gilead Sciences Inc | 13 | 7 | 6 |
| Intuitive Surgical Inc | 13 | 6 | 7 |
| Microsoft Corp | 13 | 3 | 10 |
| Paychex Inc | 13 | 0 | 13 |
| Booking Holdings Inc | 12 | 6 | 6 |
| Charter Communications Inc | 12 | 2 | 10 |
| MercadoLibre Inc | 12 | 6 | 6 |
| Meta Platforms Inc | 12 | 10 | 2 |
| Microchip Technology Inc | 12 | 8 | 4 |
| Monster Beverage Corp | 12 | 0 | 12 |
| Verisk Analytics Inc | 12 | 3 | 9 |
| Adobe Inc | 11 | 8 | 3 |
| Analog Devices Inc | 11 | 6 | 5 |
| Biogen Inc | 11 | 7 | 4 |
| CoStar Group Inc | 11 | 1 | 10 |
| CSX Corp | 11 | 2 | 9 |
| Diamondback Energy Inc | 11 | 11 | 0 |
| Intel Corp | 11 | 2 | 9 |
| Intuit Inc | 11 | 2 | 9 |
| Palo Alto Networks Inc | 11 | 5 | 6 |
| Regeneron Pharmaceuticals Inc | 11 | 9 | 2 |
| Vertex Pharmaceuticals Inc | 11 | 8 | 3 |
| Warner Bros Discovery Inc | 11 | 4 | 7 |
| Cadence Design Systems Inc | 10 | 1 | 9 |
| Dexcom Inc | 10 | 4 | 6 |
| Illumina Inc | 10 | 1 | 9 |
| KLA Corp | 10 | 5 | 5 |
| Sirius XM Holdings Inc | 10 | 0 | 10 |
| Tesla Inc | 10 | 8 | 2 |
| Texas Instruments Inc | 10 | 3 | 7 |
| Workday Inc | 10 | 2 | 8 |
| Alphabet Inc | 9 | 3 | 6 |
| Comcast Corp | 9 | 1 | 8 |
| Lam Research Corp | 9 | 3 | 6 |
| Lululemon Athletica Inc | 9 | 4 | 5 |
| T-Mobile US Inc | 9 | 4 | 5 |
| Activision Blizzard Inc | 8 | 1 | 7 |
| Align Technology Inc | 8 | 2 | 6 |
| Apple Inc | 8 | 5 | 3 |
| eBay Inc | 8 | 0 | 8 |
| NVIDIA Corp | 8 | 5 | 3 |
| NXP Semiconductors NV | 8 | 2 | 6 |
| Qualcomm Inc | 8 | 5 | 3 |
| Applied Materials Inc | 7 | 3 | 4 |
| Atlassian Corp | 7 | 3 | 4 |
| Autodesk Inc | 7 | 1 | 6 |
| Enphase Energy Inc | 7 | 6 | 1 |
| Micron Technology Inc | 7 | 5 | 2 |
| Netflix Inc | 7 | 0 | 7 |
| ON Semiconductor Corp | 6 | 3 | 3 |
| PayPal Holdings Inc | 6 | 0 | 6 |
| PDD Holdings Inc | 6 | 4 | 2 |
| Zscaler Inc | 6 | 3 | 3 |
| Amazon.com Inc | 5 | 0 | 5 |
| Advanced Micro Devices Inc | 5 | 3 | 2 |
| ASML Holding NV | 5 | 4 | 1 |
| AstraZeneca PLC | 5 | 2 | 3 |
| Synopsys Inc | 5 | 0 | 5 |
| Zoom Video Communications Inc | 5 | 3 | 2 |
| Cisco Systems Inc | 4 | 0 | 4 |
| Cognizant Technology Solutions Corp | 4 | 0 | 4 |
| CrowdStrike Holdings Inc | 4 | 3 | 1 |
| Datadog Inc | 4 | 3 | 1 |
| Electronic Arts Inc | 4 | 0 | 4 |
| JD.Com Inc | 4 | 2 | 2 |
| Marvell Technology Inc | 4 | 3 | 1 |
| Old Dominion Freight Line Inc | 4 | 0 | 4 |
| American Electric Power Company Inc | 3 | 0 | 3 |
| Airbnb Inc | 3 | 2 | 1 |
| Baker Hughes Co | 3 | 2 | 1 |
| Exelon Corp | 3 | 0 | 3 |
| Globalfoundries Inc | 3 | 1 | 2 |
| Moderna Inc | 3 | 3 | 0 |
| Xcel Energy Inc | 3 | 0 | 3 |
| Dollar Tree Inc | 2 | 2 | 0 |
| Fastenal Co | 2 | 0 | 2 |
| IDEXX Laboratories Inc | 2 | 0 | 2 |
| Keurig Dr Pepper Inc | 2 | 1 | 1 |
| Kraft Heinz Co | 2 | 1 | 1 |
| Marriott International Inc | 2 | 1 | 1 |
| PepsiCo Inc | 2 | 0 | 2 |
| Seagen Inc | 2 | 2 | 0 |
| Starbucks Corp | 2 | 0 | 2 |
| Cintas Corp | 1 | 0 | 1 |
| Constellation Energy Corp | 1 | 0 | 1 |
| Lucid Group Inc | 1 | 1 | 0 |
| Paccar Inc | 1 | 1 | 0 |
| Ross Stores Inc | 1 | 0 | 1 |
| Walgreens Boots Alliance Inc | 1 | 0 | 1 |
| Source: Morgan Stanley/Thomson | |||
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