What is the Rule of 40?
The Rule of 40 is a health test for software companies: revenue growth and free-cash-flow margin, added together, should clear forty. Fast and burning cash can pass; slow and highly profitable can pass. A company that is neither fast nor profitable fails, which is what the test is for.
How it works
Software has a genuine trade-off between growth and profitability. Spending on sales and product buys growth and suppresses margin; pulling that spending back lifts margin and slows growth. Judging such a company on either number alone rewards whichever choice it happened to make, so the rule adds them and looks at the total.
Passing tells you the trade-off is being made at a reasonable exchange rate. Failing tells you the company is spending without getting growth for it, which is the state the test exists to catch. Forty is a convention rather than a discovered constant — a widely used threshold, not a law.
The two halves are not interchangeable, and treating them as though they are is where the rule misleads. Growth is the harder half to buy and the more durable half to own; margin can be manufactured for a few quarters by cutting spending that the next few quarters will miss. Two companies at the same total can be in very different shape.
It also travels badly outside software. Applied to a business with heavy physical capital or a long cash-conversion cycle, the free-cash-flow half is measuring something structurally different, and the total stops meaning what the rule intends — which is why it is reported for software names and left blank elsewhere rather than computed for everyone.
Where you see this in the terminal
Screenerthe Rule of 40 column — a Pro metric, so a free account sees a PRO chip on every row rather than the blank that marks a name outside software
Sector dashboardsthe technology cut, where software names sit beside the peers they are judged against
The valuation enginehow free cash flow is normalized before any margin is computed from it
The conventions behind it
What this page explains in plain language, the methodology documents state as conventions: the inputs, what is rejected, and the stated limits.
More of these: every concept page. The full transparency index is at Methodology.