Meritech Capital: With Identical Rule of 40 Scores, Growth-Focused Software Companies Command Valuations Up to 2.7 Times Higher Than Profitability-Focused Peers
Meritech’s Software Pulse analysis, based on regression data from over 100 public software companies, reveals that among firms with similar Rule of 40 totals, growth-driven companies trade at a median valuation multiple of 10.9x ARR, compared to just 4.1x for profitability-driven firms. A two-factor regression further shows that revenue growth is 4.5 times more strongly correlated with valuation multiples than free cash flow margin.
In its Software Pulse report published on October 9, 2026, venture capital firm Meritech Capital analyzed the composition of the Rule of 40 across more than 100 public software companies, uncovering a result with direct implications for valuation: companies with similar Rule of 40 scores can see their market valuation multiples differ by up to 2.7 times depending on how those scores are achieved. Specifically, growth-driven companies (characterized by high revenue growth and low free cash flow margins) traded at a median multiple of 10.9x implied ARR, whereas profitability-driven companies (low growth, high free cash flow margins) traded at only 4.1x.
The Rule of 40 is the most frequently cited composite health metric in the software industry, defined as the sum of next-twelve-months (NTM) revenue growth and NTM free cash flow margin; a total score of 40 is generally considered healthy.
Meritech further quantified this disparity through a two-factor regression analysis. In a joint regression of NTM revenue growth and NTM free cash flow margin against ARR multiples, growth exhibited a correlation strength 4.5 times greater than that of profit margins—meaning a one percentage point increase in growth has the same impact on valuation as a 4.5 percentage point improvement in free cash flow margin. This aligns with the Rule of 40 composition findings: the market explicitly rewards growth over profitability when total scores are equal. Meritech also noted that public markets are concerned about the impact of AI on horizontal SaaS vendors; while most companies’ growth rates have not yet recovered, only a select few have accelerated growth through AI-enabled features.