How to Value Growth Stocks - 3 Ways to Analyze High Growth Cloud Stocks - SaaS Rule of 40 & More!

Today, I explain 3 ways to analyze growth stocks, specifically Software as a Services (SaaS) and cloud growth stocks. The Rule of 40, GRIT, and SWOT are covered in detail, then I provide my thoughts and opinions.

Rule of 40: Three ways to beat the Rule of 40. Companies can beat the Rule of 40 at all stages of their life cycle…..

1. Strong growth: Generally modestly profitable while investing in hypergrowth to build a large installed base, displace legacy vendors and attain the holy grail of becoming a platform. Beyond $1 billion in revenue, software businesses must evolve their operating model and process maturity to handle the complexities of serving multiple customer segments, with multiple products, across many countries. As growth slows, mature software companies look for ways to generate more revenue from existing customers, while becoming more efficient to increase profit margins and maintain performance that beats the Rule of 40.

2. Balanced, profitable growth: Half of the companies consistently exceeding the Rule of 40 do so with revenue growth between 10% and 30%. Such large, established companies as VMWare, Adobe and Salesforce have successfully developed new products for markets adjacent to their core, and navigated technology or business model transitions (for example, to SaaS and subscription models) to keep growing. Having climbed the S-curve, they must reorient their approach to reach the next level. Some companies accustomed to rapid growth struggle to adapt. For example, R&D spending needs to reflect the fact that subsequent waves of innovation might not be as valuable as the earlier breakthroughs, relative to the business size, and that the mix of investment may need to shift to renewing the original architecture. Disciplined and data-driven portfolio management and investment choices become increasingly important.

3. Profitability: Some companies beat the Rule of 40 with annual organic revenue growth below 10%. Established players like Oracle, SAP and Trend Micro have large, profitable flagship businesses. With growth stabilizing below 10%, companies turn to becoming more efficient and profitable—exacting pricing power, leveraging the scale and scope of large salesforces, cross-selling and expanding installed base customers, exploring new business models, increasing renewals, moderating R&D investment.

You can measure profit in a SaaS business — or any business — in many different ways. There are plenty of options such as Operation Income, Net Income, Free Cashflow, Cashflow and more, but the most well-known and most-used metric for startups and SaaS companies is EBITDA. Earnings before interest, taxes, depreciation and amortization is a way to measure profits without having to consider other factors such as financing costs (interest), accounting practices (depreciation and amortization) and tax tables.

Disclaimer: I have been investing in the stock market for over 20 years, but I am not a financial advisor or a legal professional, and I am not providing financial or legal advice. The information provided is for informational purposes only. It should not be considered legal or financial advice. You should consult with an attorney or other professional to determine what may be best for your individual needs. FIRED Up Wealth and Eric Cuka do not make any guarantee or other promise as to any results that may be obtained from using our content. No one should make any investment decision without first consulting his or her own financial advisor and conducting his or her own research and due diligence. Past performance is no guarantee of future results.

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