The 40% Rule That Built Billionaires

Good Evening! 👋

Dear Friend,

Happy Wealth Wednesday.

I have always loved growth stocks. There is nothing more exciting than spotting a trend early and watching it play out. Over the years, I have been able to predict where entire sectors were headed. Cloud computing, bitcoin miners, data companies like Palantir back in 2022, and fintech are all great examples of that.

But here is the thing. It is absolutely useless to predict that artificial intelligence will take over an entire sector, get that prediction right, but fail to pick the right company. The sector can skyrocket, and you can still lose money if you own the wrong stock.

That is why I like the Rule of 40. It gives me a way to look past the hype and focus on the fundamentals. It lets me evaluate how an individual company is performing, not just how its industry is trending. Real wealth in the market does not come from being early to a story. It comes from owning the companies that can grow fast and do it responsibly.

The Rule of 40: What It Is and Why It Matters

When you invest in growth stocks, it is easy to get caught up in the story. You hear about massive revenue growth, new technologies, and endless potential. But growth alone does not make a great company. Eventually, every business has to prove that it can grow and stay profitable at the same time.

That is where the Rule of 40 comes in.

Here is how it works:
Revenue growth rate + Profit margin = Rule of 40 score

If the number is 40 or higher, that company is generally considered healthy. It is a simple test that shows how efficiently a business is growing.

Let’s look at two examples:
Company A: 25% revenue growth + 20% profit margin = 45
Company B: 50% revenue growth + (-20%) profit margin = 30

On paper, Company B looks like the faster grower, but it is burning cash to do it. Company A is growing a little slower but is actually profitable while doing it. That is the type of growth that lasts.

I like the Rule of 40 because it helps me look past the hype. When a company can grow fast and stay profitable, it tells me they have a real business model, not just a story.

The numbers back this up. Companies that consistently meet or exceed the Rule of 40 tend to be stronger across the board. They have:

• 31% lower customer acquisition costs

• 29% lower churn

• 83% better capital efficiency

• More efficient research and development spending

• Lower sales and marketing costs as a percentage of revenue

In other words, companies that pass the Rule of 40 know how to scale without wasting money.

Research from Bain & Company found that most outperformers fall into one of three categories:

1. Hypergrowth: Revenue growth above 30% with modest profitability. Examples include Splunk, Wix, and Workday.

2. Balanced growth: Revenue growth between 10% and 30% with meaningful profitability. Companies like Adobe, Salesforce, and VMware fit here.

3. Profitability focus: Growth below 10% but very high margins. Think Oracle, SAP, or Trend Micro.

Each approach works. What matters is that the company knows what kind of business it is and can execute that strategy well.

The Rule of 40 is not perfect, but it is one of the fastest ways to tell whether a company is building something sustainable or just running on momentum.

A Simple Example

When I first sent out Palantir to readers back in early 2022, it was not a popular pick. The company was still figuring things out after going public, and most investors had already lost interest in anything tied to growth.

At the time, Palantir’s Rule of 40 score was sitting around 33. That told me they were still growing quickly but had not yet found the right balance between growth and profitability.

What caught my attention was that we were early. I believed we were getting a strong data company at a discount while anticipating that, over time, they would eventually break the Rule of 40.

And that is exactly what happened.

Palantir’s Rule of 40 progression:

• Q3 2023: 46% (17% growth + 29% margin)

• Q2 2025: 94% (48% growth + 46% margin)

That kind of improvement is rare. It shows how a company can move from chasing growth to actually becoming profitable while still expanding at a fast pace. For me, that is the moment when a company transitions from potential to performance.

The Rule of 40 helped me see that progress clearly. It is not about predicting short-term price movements. It is about identifying companies that are growing the right way and showing signs of sustainable strength.

Note: The Rule of 40 has nothing to do with valuation. It is simply a quick health test. Even though Palantir is crushing it on the Rule of 40, I still think the stock looks very overvalued right now.

What the Rule Doesn’t Tell You

The Rule of 40 is one of my favorite ways to analyze growth companies, but it is not perfect. It gives you a quick snapshot of how efficiently a company is scaling, but it does not tell the full story behind those numbers.

Take Company XYZ as an example.

Let’s say they report:
Revenue growth: 35%
Profit margin: 10%
Rule of 40 score: 45

That looks healthy at first glance. But if you dig deeper, you might find they are taking on new debt or issuing additional shares just to fund operations. Moves like that can weaken shareholder value even when the headline numbers look great.

That is why I always look beyond the Rule of 40. You need to check free cash flow, balance sheet strength, and how management reinvests profits.

If Company XYZ’s growth comes from smart operations and steady cash generation, that is a business with real staying power. But if that growth is fueled by borrowing or dilution, the story changes fast.

The Rule of 40 is a great starting point, but it should never replace real research. It helps you spot companies that are moving in the right direction, but it is up to you to decide whether that growth is built on something real.

Conclusion

The Rule of 40 is one of those simple tools that helps me slow down and think clearly when everyone else is chasing headlines. It reminds me that growth only matters if it leads somewhere.

I love growth stocks because they give you a front-row seat to innovation, but not every fast-growing company becomes a great investment. The Rule of 40 helps me focus on the ones growing with discipline. It is a quick test that filters out the hype and highlights the businesses that are actually improving their fundamentals.

It is not a magic formula, and it will not tell you what a stock is worth, but it gives you something far more important: perspective.

If you can combine that perspective with your own research and patience, you will start seeing which companies are built to last and which ones are just passing through.

Disclaimer for BeanWealth

BeanWealth is a publisher of financial education and information. We are not an investment advisor and do not provide personalized investment advice or recommendations tailored to any individual's financial situation. The content provided through our website, newsletters, and any other materials is for educational purposes only and should not be construed as financial or investment advice.

All information is provided “as is,” without warranty of any kind. BeanWealth makes no representations or guarantees regarding the accuracy, completeness, or timeliness of the information presented. The opinions and views expressed in our content are those of the author(s) and do not necessarily reflect the views of BeanWealth, its partners, or its affiliates.

Investors should perform their own due diligence and consult with a professional financial advisor before making any investment decisions. None of the information provided herein constitutes a solicitation to buy or sell any securities or financial instruments. Any projections or forecasts mentioned are speculative and subject to risks and uncertainties that could cause actual outcomes to differ.

BeanWealth, its employees, and affiliates may hold positions (long or short) in the securities or companies mentioned, and these positions may change without notice. No guarantees are made regarding the continuation of these positions.

Forward-looking statements, estimates, or forecasts provided are inherently uncertain and based on assumptions that may not occur. Other unforeseen factors may arise that could materially affect the actual outcomes or performance of the securities discussed. BeanWealth has no obligation to update or correct any information after the date of publication.

BeanWealth disclaims any liability for losses or damages, whether direct or indirect, resulting from the use of the information provided. By accessing or using any BeanWealth content, you agree to this disclaimer and our terms of service.

Unauthorized distribution, reproduction, or sharing of this content is strictly prohibited and subject to legal action.