Lesson 3.4 · 4 of 5 · The quality of a business
Healthy company growth: organic growth, EPS, CAGR and the rule of 40
Healthy growth comes from the existing business, not just from companies bought in, and is not paid for with shrinking margins or ever larger debts. You check it over several years: compare growth in revenue with growth in profit and in earnings per share, using CAGR. For software companies, the rule of 40 puts growth next to margin.
Terms in this lesson
- CAGR
- How much something grew on average per year, counting the compounding.
- EPS
- The company's net profit divided by the number of shares.
- Stock buyback
- The company buys its own shares on the market, so each shareholder's slice gets bigger.
- Rule of 40
- Sales growth plus profit margin: the balance test for tech companies.
Organic growth and growth from acquisitions
Definition
What is organic growth?
Growth in the existing business, leaving out companies bought or sold and the effect of exchange rates.
When a company buys another, the acquired company’s revenue is added to its own from the day of the deal. Total revenue jumps, even though no business sold any more. Exchange rates move the figures too: an American company selling in euros reports fewer dollars when the euro falls. That is why many companies also publish “organic” growth. It is a figure the company works out itself, not one set by accounting rules, so check it against the table that reconciles it with the reported number.
Real case
Coca-Cola in 2025
Reported revenue: +2%. Organic revenue: +5%.
Exchange rates knocked 2 percentage points off growth. Acquisitions and divestitures took off another point; in 2025 Coca-Cola carried on selling company-owned bottling operations to its partners. Without them, growth was 5%. It came mainly from prices and product mix (+4%), while the volume of concentrate sold rose by only 1%.
- +2%reported revenue, $47.9bn
- -2 pointsexchange rates
- -1 pointacquisitions and divestitures
- +5%organic revenue
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Create a free accountRevenue, profit and earnings per share: why they grow differently
Three lines for Apple’s financial years 2015-2025, all starting at 100 in 2015. Revenue ends at 178, net income at 210 and diluted earnings per share at 324. The lines move almost together until 2017, then earnings per share pulls away upwards as the share count falls.
Between financial years 2015 and 2025 Apple’s revenue grew by 78%, its net income by 110% and its earnings per share by 224%. Profit grew faster than revenue because the net margin rose from 22.8% to 26.9%. EPS grew faster still because the number of shares fell by 35%, from 23.2 billion to 15.0 billion (diluted shares, adjusted for the 4-for-1 split in 2020), after years of buybacks.
Definition
How do buybacks move earnings per share?
The same profit, divided by fewer shares, gives a higher EPS.
Buybacks do not make the business sell any more. They split the profit across fewer shares, so each share gets a bigger slice. It is not “fake” growth, but it is a different kind of growth from the business itself, and the question is what price the shares were bought back at. The lesson on buybacks goes into detail. Watch for the reverse too: a company that pays its staff heavily in shares increases its share count, and EPS grows more slowly than profit.
“Bought” growth: shrinking margins and debt
Any company can sell more if it cuts prices, gives customers longer to pay or buys other companies with borrowed money. Sales go up, but the profit on every dollar of sales falls and the risk rises. That is “bought” growth.
The rule of 40 and CAGR: how to measure growth
Definition
What is the rule of 40?
For a software company, revenue growth (%) plus profit margin (%) should come to at least 40.
The rule was popularised by the investor Brad Feld on 3 February 2015; he says he heard it from a late-stage investor at a board meeting. Feld meant it for subscription software companies with at least $50 million of revenue, and he preferred the EBITDA margin. Many analysts now use the free cash flow margin instead. The idea: a company can grow fast while losing money, or slowly with high profits, but the sum of the two shows the balance.
30 + 15 = 45: above 40.
Definition
How is CAGR calculated?
(End value ÷ start value) to the power of 1 ÷ number of years, minus 1.
CAGR, the compound annual growth rate, is the average growth per year with the years compounded. Apple’s revenue rose from $233.7bn in financial year 2015 to $416.2bn in 2025: 416.2 ÷ 233.7 = 1.781, to the power of 1/10, minus 1 = 5.9% a year. EPS grew by 12.5% a year. A simple average of yearly growth rates can mislead: +50% one year and -50% the next average out at 0%, yet leave you with a 25% loss.
Lessons are educational. They are not a recommendation to buy or sell. Investing involves risk and you can lose money. Sources: Coca-Cola, fourth-quarter and full-year 2025 results (10 February 2026, SEC): revenue +2% to $47.9bn, organic revenue +5%, price/mix +4%, concentrate sales +1%, currency -2%, acquisitions and divestitures -1%; Apple, Form 10-K annual reports for financial years 2017, 2020, 2022 and 2025 (revenue, net income, diluted EPS and diluted shares for financial years 2015-2025; EPS for 2015-2017 divided by 4 for the 2020 split); Microsoft, Form 10-K annual reports for financial years 2018 and 2026 (revenue of $96,571m in 2017, $245,122m in 2024, $281,724m in 2025 and $331,839m in 2026; operating cash flow and additions to property and equipment for 2025 and 2026); Brad Feld, “The Rule of 40% For a Healthy SaaS Company”, feld.com, 3 February 2015.