A Rule of 40 calculator adds a software company's revenue growth rate to its profit margin, and a combined score of 40 or higher is the traditional benchmark for a healthy business. The most common public-market version uses trailing-12-month (TTM) revenue growth plus TTM free cash flow (FCF) margin. Below: the formula, a step-by-step CrowdStrike ($CRWD) calculation, a scorecard of 12 US-listed software and security names built from quarterly filings through October 2026, and the stock-based compensation problem that flatters a lot of those scores.
The appeal is obvious. Growth and profit pull against each other, and the Rule of 40 lets a 50% grower lose 10 cents on the dollar while asking a 10% grower to earn 30. One number, one bar. The trouble is that "profit margin" is doing a lot of quiet work in that sentence.
The Rule of 40 formula
The math fits on a sticky note:
Rule of 40 score = revenue growth % + profit margin %
The idea was laid out in a February 3, 2015 post on Brad Feld's blog, which credited it to an unnamed late-stage investor and put it plainly: growth rate plus profit "should add up to 40%." That post preferred EBITDA as the profit line. Public-market investors have since drifted toward cash. The usual choices:
- FCF margin: operating cash flow minus capital expenditures, divided by revenue. The most common screen for listed software stocks, because both inputs come straight off the cash flow statement in every 10-Q and 10-K.
- EBITDA margin: earnings before interest, taxes, depreciation and amortization. Popular in private markets, but "adjusted" EBITDA definitions vary by company.
- GAAP operating margin: the strictest version, because it treats stock-based compensation as the expense it is.
We use TTM FCF margin for the main score, then stress-test it against the stricter measures. TTM matters because quarterly cash flow is lumpy. Snowflake's ($SNOW) single-quarter FCF margin was 59.6% in the quarter ended January 31, 2026 and 5.4% in the quarter ended July 31, 2026. Score either quarter alone and you get nonsense. Four quarters smooth out the seasonality.
Worked example: CrowdStrike, step by step
CrowdStrike's latest reported quarter is fiscal Q2 2027, which ended July 31, 2026 and was filed August 27, 2026. Here is the full calculation from its quarterly statements (figures from Financial Modeling Prep, rounded):
- TTM revenue. Add the last four quarters: $1.234B (Oct. 2025) + $1.305B (Jan. 2026) + $1.386B (Apr. 2026) + $1.471B (Jul. 2026) = $5.396B.
- Prior TTM revenue. Add the four quarters before that: $1.010B + $1.059B + $1.103B + $1.169B = $4.341B.
- Revenue growth. $5.396B / $4.341B - 1 = 24.3%.
- TTM free cash flow. Operating cash flow of $2.017B minus capital expenditures of $0.444B = $1.573B.
- FCF margin. $1.573B / $5.396B = 29.1%.
- Score. 24.3 + 29.1 = 53.5 (the unrounded inputs sum to 53.45).
CrowdStrike clears the bar by more than 13 points. Hold that thought: over the same four quarters it recorded $1.231B of stock-based compensation, or 22.8% of revenue, and its GAAP operating margin was -2.2%.
Rule of 40 scorecard: 12 software stocks
The same method applied to 12 software and cybersecurity names, using the latest quarterly filings in FMP data as of October 19, 2026. Fiscal calendars differ: Adobe's ($ADBE) latest quarter ended August 28, 2026; Fortinet, Cloudflare, Datadog and ServiceNow reported through June 30, 2026; the rest through July 31, 2026. The windows are offset by up to two months, so treat close scores as ties.
| Ticker | Latest quarter ended | TTM revenue growth | TTM FCF margin | Rule of 40 score |
|---|---|---|---|---|
| $DDOG | Jun 30, 2026 | 31.5% | 29.1% | 60.6 |
| $PANW | Jul 31, 2026 | 24.5% | 35.8% | 60.3 |
| $FTNT | Jun 30, 2026 | 18.8% | 41.4% | 60.2 |
| $ADBE | Aug 28, 2026 | 12.0% | 42.1% | 54.2 |
| $SNOW | Jul 31, 2026 | 32.0% | 22.0% | 54.0 |
| $CRWD | Jul 31, 2026 | 24.3% | 29.1% | 53.5 |
| $NOW | Jun 30, 2026 | 22.2% | 31.1% | 53.3 |
| $ZS | Jul 31, 2026 | 25.4% | 25.4% | 50.8 |
| $NET | Jun 30, 2026 | 33.5% | 15.1% | 48.6 |
| $CRM | Jul 31, 2026 | 11.2% | 34.5% | 45.7 |
| $OKTA | Jul 31, 2026 | 11.2% | 31.6% | 42.9 |
| $S | Jul 31, 2026 | 21.1% | 3.5% | 24.6 |
Eleven of 12 pass. The only miss is SentinelOne ($S) at 24.6, where solid 21.1% growth runs into a 3.5% FCF margin. Notice the different routes to the same neighborhood: Fortinet gets to 60.2 mostly on margin, Datadog gets to 60.6 on a near-even split, and Cloudflare ($NET) posts the fastest growth on the list, 33.5%, but only a 15.1% FCF margin.
That spread is the point of the rule and also its weakness. A scorecard this crowded above 40 suggests the FCF version is a fairly easy bar for this group of scaled software companies. Which brings us to what FCF leaves out.
The stock-based compensation catch
Free cash flow adds stock-based compensation (SBC) back, because paying employees in shares costs no cash. It does cost shareholders: new shares dilute existing owners, and buybacks used to offset that dilution cost real cash, which shows up in financing, not in FCF. A stricter calculator subtracts SBC from FCF before scoring, or swaps in GAAP operating margin, which already counts it.
| Ticker | FCF score | SBC % of revenue | FCF minus SBC margin | SBC-adjusted score | GAAP operating margin |
|---|---|---|---|---|---|
| $FTNT | 60.2 | 3.9% | 37.5% | 56.2 | 32.4% |
| $PANW | 60.3 | 12.2% | 23.6% | 48.1 | 6.1% |
| $ADBE | 54.2 | 8.0% | 34.1% | 46.2 | 35.7% |
| $DDOG | 60.6 | 20.7% | 8.4% | 39.9 | 0.4% |
| $NOW | 53.3 | 14.8% | 16.3% | 38.4 | 11.4% |
| $CRM | 45.7 | 8.3% | 26.1% | 37.4 | 21.4% |
| $CRWD | 53.5 | 22.8% | 6.3% | 30.6 | -2.2% |
| $NET | 48.6 | 20.2% | -5.1% | 28.4 | -14.1% |
| $OKTA | 42.9 | 16.4% | 15.3% | 26.5 | 7.7% |
| $ZS | 50.8 | 24.5% | 0.9% | 26.3 | -4.0% |
| $SNOW | 54.0 | 30.2% | -8.2% | 23.8 | -22.8% |
| $S | 24.6 | 29.3% | -25.8% | -4.7 | -27.0% |
The pass list shrinks from 11 names to three: Fortinet, Palo Alto Networks ($PANW) and Adobe. Datadog misses by a tenth of a point.
Snowflake is the cleanest illustration. On FCF it scores 54.0, ahead of CrowdStrike. But SBC equaled 30.2% of its TTM revenue, its GAAP operating margin was -22.8%, and its FCF minus SBC margin was -8.2%. Its SBC-adjusted score is 23.8. Same company, same quarter, a 30-point swing depending on one definition.
At the other end, Fortinet barely moves. SBC was 3.9% of revenue, so its score slips from 60.2 to 56.2 and its 32.4% GAAP operating margin backs up the cash number. Adobe gives up 8 points, from 54.2 to 46.2, and still passes, with a 35.7% GAAP operating margin. When the FCF score and the strict score tell the same story, the score is telling you something real.
Common Rule of 40 mistakes
- Annualizing one quarter. Palo Alto's latest quarter, ended July 31, 2026, showed revenue up 34.4% year over year, and compounding its sequential jump over four quarters implies about 66.5%. Its TTM growth was 24.5%. A spike like that is a cue to read the filing and find out what changed, not a number to plug in.
- Letting acquisitions pose as growth. Bought revenue lands in reported revenue, so a deal can lift the growth term without a single new customer. Cybersecurity M&A is a live topic; see our coverage of Proofpoint's Varonis acquisition. Check whether a company discloses organic growth before trusting a jump.
- Mixing fiscal periods. Comparing a June quarter to an August quarter is fine if you label it; comparing one company's annual figure to another's TTM figure is not.
- Mixing margin definitions. EBITDA for one name and FCF for another is not a comparison. Pick one definition and apply it to every company on the list.
- Treating 40 as a buy signal. The score measures the business, not the stock. It says nothing about valuation or what the market already expects. Salesforce ($CRM) scored 45.7 on FCF, yet its outlook is still hotly debated, as in our piece on the Salesforce double upgrade and the "SaaSpocalypse" thesis.
No version of this score predicts returns, and nothing here is investment advice. It is a filter for asking better questions. For more software and AI coverage, browse the Technology section or the latest stories on the What's On Finance homepage.
Bull/Bear Verdict
Bull Case: Where the metric helps: it puts growth and profitability on one comparable scale, it takes five minutes from public filings, and when the FCF score and the SBC-adjusted score agree, as with Fortinet (60.2 and 56.2), it flags a business that funds its own growth.
Bear Case: Where it misleads: the popular FCF version ignores stock-based compensation, so Snowflake scores 54.0 while posting a -22.8% GAAP operating margin. It also ignores valuation, acquired revenue and fiscal-calendar mismatches, and 11 of 12 names passing suggests the bar is not very selective.
FAQ
What is a good Rule of 40 score?
The traditional bar is 40 or higher. On the TTM FCF version, 11 of the 12 software names above cleared it in filings through October 2026, with scores from 42.9 to 60.6. On an SBC-adjusted basis only three did, so a score well above 40 on both versions is the more demanding test.
Should the Rule of 40 use FCF margin, EBITDA margin or operating margin?
FCF margin is the most common choice for listed software stocks because it comes straight from the cash flow statement. EBITDA is common in private markets. GAAP operating margin is the strictest because it counts stock-based compensation. Whatever you pick, use it consistently across every company you compare.
Why use trailing-12-month figures instead of the latest quarter?
Quarterly revenue and cash flow are seasonal. Snowflake's single-quarter FCF margin ranged from 5.4% to 59.6% across the four quarters through July 31, 2026. Summing four quarters for both revenue and FCF removes most of that noise.
Does a stock with a high Rule of 40 score outperform?
The score measures operating performance, not share price. It does not account for valuation or expectations, and no Rule of 40 result predicts returns. Use it as a screening question, not a verdict.