Learn what the Rule of 40 is in investing and why you should use it to find the best investments. Explore LevelFields' free Rule of 40 Stock Screener.
Trading Strategies
March 1, 2025
Table of Contents
Investors looking at high-growth companies often struggle to decide which ones are strong enough to survive long-term. Many tech and SaaS businesses grow quickly, but traders can have trouble making a profit.
The Rule of 40 is a simple way to check if a company is growing fast enough while staying financially healthy. This rule looks at the revenue growth rate and profit margin together to check the balance between growth and profitability.
In this article, we will talk about what the Rule of 40 is and how it works. We will also talk about why this rule is important and the benefits it could provide for your investment strategies.
The Rule of 40 is a way for investors to check if a SaaS company is growing fast enough while staying financially stable. It combines revenue growth rate and profit margin into a single percentage-based score.
The formula is:
Revenue Growth Rate (%) + Earnings Before Taxes, Depreciations, & Interest Margin (%) = Rule of 40 Score
This free Rule of 40 Stock Screener by LevelFields makes this process much easier. It’s a free screener that you can use to enter a stock symbol and get an instant Rule of 40 score.
The screener quickly checks whether a company meets this standard. It helps investors in balancing growth. They can also focus on stocks that fit their strategy.
The Rule of 40 is a simple way to check if public SaaS companies are growing fast enough while keeping their finances stable. It combines two key numbers: revenue growth rate and profit margin.
If the sum of these two percentages is 40% or higher, the company is considered to have a balanced trade-off between growth and profitability.
This measures how much a company’s revenue has increased over a set period, usually year-over-year (YoY).
High-growth business models, especially in the SaaS industry, often focus on expanding their customer base and increasing sales. A strong revenue growth rate means the company attracts more users or sells more services.
The EBITDA margin shows how much money the company keeps after covering costs. SaaS companies often have low-profit margins early on since they spend heavily on customer acquisition, product development, and operations.
Profitability is typically measured using one of the following:
If a company has a profit margin of 10%, it means that for every $1 in revenue, it keeps $0.10 as profit.
Stock traders look for companies with strong growth potential while managing financial risk. The Rule of 40 helps you measure whether a SaaS stock is growing at a steady pace while keeping its finances stable.
A company that meets or exceeds 40% is often considered a better choice for stock trading since it shows both expansion and financial control.
Not all high-growth stocks are smart investment choices. Some companies report strong revenue growth but operate at a loss, which makes them unstable. Others may focus too much on profit and fail to expand.
The Rule of 40 helps avoid companies that may not have a stable long-term outlook. For example, if a company reports 50% revenue growth but has a negative profit margin of -20%, its Rule of 40 score would be 30, which falls below the standard.
This suggests that while the company is expanding, it is also losing a lot of money, which increases the risk of financial problems.
If you focus on both short-term and long-term opportunities, use the Rule of 40 to find stocks that are not only growing but also managing costs properly.
Stocks that consistently maintain a 40 score or higher are often more stable. They are a better choice for those who hold positions for longer periods.
Companies with a strong Rule of 40 score are also more likely to handle market downturns better than companies relying only on revenue growth. For traders, this means fewer sharp losses and better stock price performance over time.
Traders often focus on stocks that show high revenue growth because fast-growing companies attract more market interest. However, companies that only focus on revenue while ignoring profit can face problems in the long run.
The Rule of 40 helps you identify stocks that are:
This can make it a stronger choice for trading, as companies with strong scores are often more attractive to investors.
Stock traders need to act fast. Instead of manually calculating scores, traders can use the free Rule of 40 Stock Screener by LevelFields to instantly see which companies meet the standard.
This helps traders make decisions quickly and focus on stocks that show both growth and financial balance.
Traders can use this tool to find stocks with the potential for steady growth and lower risk. It makes trade decisions faster and more reliable.
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It analyzes over 1.8 million market events each month to deliver data-backed insights so you can make informed decisions instead of relying on speculation. Trading should be based on facts, not guesswork.
LevelFields also offers a free Rule of 40 screener you can use to see which companies you should invest in.
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The 40% rule, also called the Rule of 40, is a way to measure whether a SaaS company is growing at a reasonable rate while keeping its finances stable.
It is calculated by adding the revenue growth rate and EBITDA margin. If the total is 40 or higher, the company is considered to have a good balance between growth and profitability.
The Rule of 40 is a tool investors use to evaluate a company’s ability to expand while keeping costs under control. It combines two key numbers: revenue growth rate and profit margin. If the sum is 40% or more, the company is seen as managing both well.
This method is commonly applied to SaaS businesses, where companies often reinvest earnings into expansion rather than prioritizing profit. Many investors use this rule as an initial check before looking deeper into financial reports.
NVIDIA (NVDA) is a technology company known for its role in GPUs, AI computing, and cloud services. Investors apply the Rule of 40 to check whether its revenue growth and profit margin add up to at least 40%.
NVIDIA has experienced strong revenue expansion due to demand for AI technology, data centers, and gaming hardware. At the same time, its profit margin fluctuates based on factors such as production costs and market conditions.
Checking NVIDIA’s financial reports helps investors see if it meets the Rule of 40 and how it compares to other technology companies.
Amazon (AMZN) operates in multiple industries, including e-commerce, cloud computing (AWS), and digital services. Since different segments of Amazon’s business have varying levels of growth and profit, the Rule of 40 is mostly applied to its cloud computing division rather than the company as a whole.
AWS generates strong revenue growth and higher profit margins compared to Amazon’s retail segment. Analysts often use the Rule of 40 to measure AWS’s financial performance separately from Amazon’s total business.
Investors who apply this rule to Amazon must consider how each part of the company contributes to its overall numbers.
For those who want a quick way to check whether a stock meets this standard, the free Rule of 40 Stock Screener by LevelFields provides instant results without manual calculations.
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