In this blog post, we will examine how “Rule of 40” Plays out in reality by analyzing financial data from 200+ publicly traded saas firms
This project is an extention of a prior smaller project to examine different paths to achieve “Rule of 40”. Link to Prior project:
https://www.eliza-bui.com/automate-boring-stuffs/python-scrape-rule-of-40
https://www.eliza-bui.com/finance/different-paths-to-rule-of-40-analysis-of-5-stocks
If you would like to see the many colorful and informative charts, please head out to my Github’s repository to check out the Jupiter Notebook posted there.
https://github.com/ExcellentBee/Learning-Everyday/blob/main/Rule%20of%2040%20Analysis%20-%20Scrape%20200%2B%20stocks.ipynb
Special Note: I have noticed that some tickers don’t have accurate financial data when comparing the results scraped from Alpha Vantage to 10-Q or 10-K filings. I emailed Alpha Vantage about those discrepancies. Thus, readers should only view charts and tables below to understand the “big picture”, not to trust every single data point scraped from the internet.
I. Data Collection and Preparation
We follow the same data scraping steps as in the prior project, the only difference here is that the size of stock list is larger (245 tickers to scrape, 235 results returned) so it takes a few more minutes to request data via API. After data is downloaded, the same steps of cleaning, checking, and standardizing as in prior projects, again with some extra steps due to more layers of complexity with vastly larger dataset.
II. Data analysis
Focusing on data in the last 4 years, 2020-2023, we have the following statistics summary table for the 5 main metrics we care about
Observations
Number of entries in column "YoY Rolling 4Q Revenue Growth" is less than total rows due missing data in prior 3 quarters, often occurring at initial phases of data initiation (new IPOs will need at least 4 quarters of filings to get Rolling 4Q Revenue)
There are wide ranges of Revenue and EBITDA, indicating that this data set encompasses companies of all sizes
Median value for Revenue Growth of 21% is less than half of its Mean value of 51%, indicating that there are significantly higher revenue firms (like Apple, Google, Amazon) skewing the average to the up side (see project’s notes on why I leave firms that are not purely SaaS plays in the dataset)
Median value for EBITDA Margin of -3% is more positive than its Mean value of -16%, indicating that there are firms with significantly negative EBITDA Margin skewing the average to the down side
Median value for Revenue Growth + EBITDA Margin of 24% is much lower than its Mean value of 44%, indicating that there are firms with significantly higher (Revenue Growth + EBITDA Margin) performance skewing the average upward
Data points in the top quartile (75pctl) have (Revenue Growth + EBITDA Margin) exceeding 40%, meaning that these data points made it to the "Rule of 40" Club
Let's cut off the upper and lower 1% data points to see the distribution for each Calendar Year better
Observation: There are outliers in the upper end of Revenue Growth and in the lower end of EBITDA Marign skewing the histograms of the 2 metrics and their SUM. Two main reasons (specific examples in analysis by Calendar Year below)
When revenue first takes off, low demoninators makes YoY growth % astronomically high
When companies starts, revenue is minimal but EBITDA is significantly larger (initial investments into R&D and Operation), resulting in negative numerator (vs small denominator)
Observations: Distribution makes more sense here
Revenue Growth is right-skewed, peaking between 10% and 20%
EBITDA Margin is left-skewed, peaking between 0% and 5%
Revenue Growth + EBITDA Margin seems more bell-shaped, peaking at round 20%
Let's look at distribution of (Rev Growth + EBITDA Margin) by Calendar Quarters
Observation: As noted above, median value for (Rev Growth + EBITDA Margin) is around 25%. 2021 and 2022 seem to have more variations in IQR than 2020 and 2023 (some companies haven't reported Q4 2023 result as of the time of this analysis)
III. Analytics and vizualization: 2020-2023
1. What are percentages of tickers achieving Rule of 40/50 in each quarter in each year?
2. Charting Revenue Growth vs EBITDA Margin from lastest filing (in 2023) and Rule of 40
In the latest filing in 2023* Correlation coefficient between YoY Revenue Growth and EBITDA Margin % (Rolling 4Q) is 0.1172* Percentage of tickers with 'YoY Rev Growth + EBITDA Margin' > 40%: 17.09%* Percentage of tickers with 'YoY Rev Growth + EBITDA Margin' > 50%: 9.40%Observations:
As the blue Regression Line shows, there is a slight positive correlation between YoY Revenue Growth and EBITDA Margin (Rolling 4Qs)
The red line separates stocks achieving Rule of 40 in the latest filing in 2023 (those above the red line) from those not achieving such Rule. Around 17% of stocks made it to "Rule of 40" club in this chart
The green line separates stocks achieving Rule of 50 in the latest filing in 2023 (those above the green line) from those not achieving such Rule. Around 9.4% of stocks made it to "Rule of 50" club in this chart
3. List of Tickers achieving “Rule of 50” and “Rule of 40” in ALL quarters between 2020-2023
Varonis Systems (VRSN), StoneCo (STNE), Netflix (NFLX), Microsoft (MSFT) are 4 stickers achieving Rule of 50 for all quarters in period 2020-2023
4. Among tickers achieving Rule of 40, what's the contribution of Revenue Growth vs EBITDA Margin?
Observation: In general, Revenue Growth contributes 2x more to Rule of 40 achievement than EBITDA Margin, indicating that the list of firms in consideration contains a lot of early stage hyper growth firms
Observation: The slope of the regresion line confirms my prior guess that in lower-revenue firms, Revenue Growth contributes significantly more to Rule of 40 achievement than EBITDA Margin
5. Among tickers achieving Rule of 50, what's the contribution of Revenue Growth vs EBITDA Margin?
Observation: If we only focus on tickers achieving Rule of 50, the contribution of Revenue Growth is even larger, averaging at 74% compared to 70% in the case of Rule of 40
6. List of tickers relying exclusively (>=100%) on revenue growth to meet Rule of 40 in any quarters within 2022-2023
7. List of tickers relying exclusively (>=100%) on EBITDA margin to meet Rule of 40 in any quarters within 2022-2023
8. What are correlations between Revenue and EBITDA, Revenue Growth and EBITDA Margin in 2020-2023?
Observation:
LTM Revenue is highly correlated with LTM EBITDA because EBITDA is a function of Revenue (Revenue - Opex)
LTM Revenue is slightly negatively correlated with YoY Revenue Growth because the larger the denominator/revenue in absolute number, the harder it is to achieve higher % growth
9. Does the stock market reward “Rule of 40” club members with higher ev/revenue multiple? work in progress
Scrape stock price (dynamically updated at end of week/month) and outstanding shares to calculate Market Cap, then scrape Debt and Cash from Balance Sheets
Calculate EV = Market Cap + Debt - Cash
Calculate EV/Revenue Multiple for each ticker
Calculate correlation and chart EV/Revenue multiple vs (Rev Growth + EBITDA Margin) score to see how they are related