A PBV ratio of more than 1 accompanied by a PE of more than 16 indicates that the market has identified these stocks as having the potential to register strong earnings growth. A high return on net worth also indicates that sustainable earnings can grow without any major changes in the nature of operations or capital structure.

Strong growth in free cash flows indicates that the good times have already started. Free cash flows refer to net profits adjusted for net capital investment and changes in working capital. Capital expenditure higher than depreciation reduces free cash-flow, and vice-versa. Similarly, increase in working capital reduces free cash-flow, and vice-versa.

The generation of free cash flows is a sign of operational strengths enjoyed by the firm. Strong growth in dividends indicates that the management is confident that the good times will last.

Rich valuations: By conventional parameters, the stocks selected would be considered richly valued. The average price to book ratio of the stock is 10 while the average price to earnings is 24. This is substantially higher than the average for most relevant indices such as Nifty or BSE 200. Except for Wipro, the market cap of all the stocks is less than Rs 10,000 crore. And except Dabur, Nicholas Piramal and Monsanto India, the market cap of all the stocks is above Rs 5,000 crore.

The valuations, however, should not deter you if the companies deliver on growth. The potential for growth is high if the return on net worth is any indication. Except for Gujarat Ambuja and Monsanto India, the return on net worth of all the other companies is higher than 25 per cent.

The free cash flows of these companies have grown at above 100 per cent in the past two years. These companies have also jacked up dividends by about 50 per cent in each of the past two years. These factors reinforce the confidence behind expectations of steady and above average growth in earnings.

Key risks: Excepting, Bharat Forge, all these companies are also not highly leveraged, signalling low financial risk. The margin of safety is however is pretty low in these stocks. If the earnings of these companies grow only at the average for the industry, returns from these stocks will be poor.

In case of any setback to earnings growth, the slump in stock price will be substantial. This is, however, part of the game of investing in growth stocks. The range of expected returns will be between minus 30 per cent and plus 30 per cent. These risks can be minimised if you hold for a longer term of more than three years.

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