As we head into earnings season, we have analyzed the Rule of 40 relavative to valuation for the major software SaaS names.
The Rule of 40 is a rule of thumb that adds revenue growth and and margin (we use FCF margin). In general, companies above 40 trade a premium valuation.
In the chart above, we can see that the Rule of 40 is generally correlated with EV/Sales. Companies above Rule of 40 are trading at multiples greater than 10x EV/Sales.
Microsoft appears to be trading at a premium to the trendline. This could be attributed the Gen AI announcements as well as strong performance in its Azure cloud business.
Workday is on the cusp of breaking through the Rule of 40. In it’s recent Analyst Day, the company guided long-term subscription revenue growth of 17-19% and Free Cash Flow of ~25%.