Rule of forty stopped being a hurdle and became a target

It traded at 234.61 this morning, -1.43% on the session. The rule of forty was a useful heuristic. It has been used as a target for long enough that it has stopped being useful.

The original idea

Growth rate plus profit margin should exceed forty. The point was to stop people admiring growth funded by unlimited losses, or profitability achieved by starving a growing business. A single number that punished both failure modes.

Sensible. It also had the property of being easy to optimise towards, which is the problem with every good heuristic that becomes widely adopted.

Why the composition matters more than the total

Forty made of thirty growth and ten margin is a fundamentally different company from forty made of ten growth and thirty margin. The first is a business expanding its market. The second is a business harvesting one.

Both print forty. Only one of them prints forty again in three years.

• The split, tracked over time rather than at a point
• Whether margin improvement is operating leverage or spending cuts
• Sales and marketing as a share of revenue, and what happened to growth when it fell
• Whether the growth remaining is price or volume

That last one is the sharpest test. Growth carried by annual price increases on an existing customer base is a different thing to growth from new customers, and the composite metric cannot tell them apart.

Why I am flat

When the total holds up because the mix shifted from growth to margin, the number is stable and the business is changing.

What would move me

Growth stabilising rather than continuing to trade down against margin. I do not need it to reaccelerate. I need it to stop being the side of the equation that gives way each year.