Translation: Original published in Finnish on 1/22/2025 at 7:44 am EET.

We are launching our own Rule of 20 for the IT services sector, which we believe works well, if not best, as a single parameter to measure the operational performance of the sector and especially of the companies. In our view, a score of 20 or higher is an excellent performance. Of course, today's market is more challenging than it has been during the past 10, and the Rule of 20 is harder to achieve. Between 2018 and 2023, several companies achieved excellent performance, but we estimate that none did so last year and only one will this year. For the IT services sector as a whole, the Rule of 20 score for the current year is 10, which is just about satisfactory and reflects the still challenging market situation. However, the differences between companies are again clear, and the long-term performers stand out.

Rule of 20 is based on organic growth and EBITA margin

We are launching our own Rule of 20 for the IT services sector, which we believe is a good, if not the best, single metric to measure a company's operational performance. Traditionally, a similar calculation has been made for SaaS companies (Rule of 40), but due to the different business models, we apply a different scale and fine-tuned parameters to the IT services sector. To calculate the Rule of 20 for the IT services sector, we use the sum of organic growth and EBITA margin.

Some companies make ongoing investments in intangible assets (e.g. software), which should be reflected in EBITA through depreciation. Therefore, in order to make the figures as comparable as possible, only the amortization of acquisitions should be adjusted back into EBITA. This EBITA corresponds to the adjusted EBIT used in our reports and on our website. EBITA should be calculated using the formula:

Historically, organic growth of 10% and an EBITA margin of 10% could and still can be considered good/excellent performance, hence the Rule of 20. This parameter also considers the different strategic stages of companies. For example, if a company invests in growth at the expense of profitability, it can still achieve a good number, as is currently the case in the IT services sector Digital Workforce, or in Witted's history. In a few companies the software business plays a small role, or for Tietoevry it is quite significant, but the companies we follow are mainly service companies and, in our opinion, quite comparable in this sample.

However, it is worth noting that low profitability is not in itself a barrier to shareholder value creation if the company is able to grow organically and with consistent profitability. A good extreme example of this is Ework, listed in Sweden, which is a higher-end resource brokerage firm (e.g., IT consultants). The company's EBIT margin hovers around 1%, but strong growth and consistent profitability have resulted in an excellent total shareholder return over the company's history. Among the companies we follow, Witted (subcontracting-oriented business model) and Loihde (structurally lower profitability of physical security business) in particular have somewhat lower than average profitability potential under the current business structure.

In general, we consider a Rule of 20 score of 20 or higher to be excellent performance, 15-19 to be good performance, 10-14 to be decent performance, and less than 10 to be poor performance. The market situation of course influences how easy/difficult it is to reach good levels. However, over a longer period of time, it is clear which companies do well and which do poorly in the long run.

Historically, several have achieved repeated excellence

Of course, today's market is more challenging than it was 10 years ago, and it is more difficult to achieve the Rule of 20. In 2018-23, the median Rule of 20 score for the IT services sector was 15, which is a good level, while the average was as high as 22, which is an excellent level. However, the average is boosted by the strong growth of two small companies (Digital Workforce and Witted) in their early years. Over the longer horizon of 2018-2023, the above-mentioned strong performers, as well as Netum and especially Gofore, delivered excellent performances. Gofore's excellence is underscored by its strong performance in a much larger size category, where growth is more difficult to sustain.

Source: Inderes, * growth only for 2020-2023

We expect only a few companies to reach good levels in 2025

Last year was a very challenging market, and we do not believe that any company achieved an excellent or even a good performance under the Rule of 20. In 2025, we forecast that only Digital Workforce will achieve excellent performance on the Rule of 20. We expect Gofore and Netum to achieve a good performance in 2025. The weak market continues to limit the ability of many companies to realize their potential. The median organic growth forecast is 3% in 2025, compared to 9% in 2018-2023. Similarly, the median EBITA margin is 7%, slightly below the 8% for 2018-2023. Thus, the sector's Rule of 20 score calculated from the median is for the current year 10, which is barely satisfactory.