The rule of forty describes a business, not a price

Growth plus margin comfortably above forty is a useful test of a software company's health. Passing it says the business is balanced between expansion and efficiency. It says nothing about what the shares should cost, and that is where the argument usually goes wrong.

Healthy is not the same as cheap

The rule of forty is a description of the business. The valuation is a forecast of how long the growth lasts. A company can pass the test comfortably while its multiple already assumes it will pass it for a decade.

When growth decelerates even slightly, the business still looks healthy and the shares re-rate anyway, because the forecast changed.

What I'm watching

• Revenue growth, and its rate of change
• Operating margin, and whether it is rising as growth slows
• The multiple against peers with similar growth

Where I stand

Short, on a valuation that assumes the growth rate holds for a very long time. The business passes the test; the price asks for more than the test can say.

What would change my mind

Growth reaccelerating from a larger base. That would justify the multiple on its own terms and make the forecast embedded in the price look reasonable.