A software heuristic that revenue growth rate plus profit margin should exceed 40, treating growth and profitability as interchangeable.
The rule acknowledges that a subscription business can rationally spend its way to growth or harvest its way to margin, and that investors should accept either provided the sum is high enough. The margin used is usually fcf-margin or adjusted operating margin.
It is a screen, not a law. A company at 60% growth and negative 15% margin scores 45 and may be excellent; one at 5% growth and 35% margin scores 40 and is a very different asset with a very different multiple.
Example: Northwind Cloud grows 31% with a 6% free cash flow margin, scoring 37, just under the threshold. Shifting $8M of sales spending would lift the margin enough to clear it at the cost of a few points of growth.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Margin and leverage. A $5,000 deposit can control a $100,000 position, which is 20:1 leverage. Because the loss is measured on the full $100,000, a 2.5% move against you halves the deposit and brings a margin call, and a 5% move uses all of it.
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