SaaS EBIT margin and the Rule of 40

The Rule of 40 says a healthy SaaS business has growth rate plus EBIT margin above 40. A 30% grower with 10% EBIT margin clears. A 15% grower needs 25% EBIT margin to clear. GAAP SaaS EBIT is usually negative because of SBC; adjusted EBIT is the figure SaaS investors actually trade on^[Damodaran].

Typical SaaS EBIT margins (2026)

Damodaran's "Software (System & Application)" bucket sits at 32.98% unadjusted operating (EBIT) margin in the Jan-2026 update; "Software (Internet)" reads just 3.69% unadjusted, and 9.52% on an EBITDA/Sales basis. Damodaran's operating margins are reported GAAP figures that expense stock-based compensation in full, so the adjusted-EBIT margins SaaS investors trade on sit above these readings once SBC is added back.

The Rule of 40

Rule of 40 score = Revenue growth (%) + EBIT margin (%)

Investors expect a score above 40 for a high-quality SaaS business. The growth side usually carries the score for sub-scale names; the margin side carries the score for mature names like Adobe or Autodesk.

Why GAAP vs adjusted matters

SBC is often a very large share of SaaS revenue: Snowflake's FY25 stock-based compensation of $1.56bn was roughly 43% of its $3.63bn revenue. Adding SBC back flips many SaaS names from GAAP-loss-making to adjusted-profitable.
The SEC permits the adjusted measure provided the reconciliation is shown^{[Reg G]}.
See SBC line-item page.

See Snowflake FY25 for the canonical worked example.