Forget the FTSE 100: these small-cap dividend growth stocks could help you retire wealthy

Roland Head suggests two small-cap growth stocks that could hammer the FTSE 100 (INDEXFTSE:UKX).

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If you really want to make big money in the stock market, it can pay to focus on smaller companies with the potential to deliver years of market-beating growth.

One of my favourite small-cap stocks is rail and transportation data specialist Tracsis (LSE: TRCS). Shares in this £179m software firm have risen by 252% over the last five years, compared to a gain of just 18% for the FTSE 100.

Tracsis shares were up again on Tuesday, gaining 10% after the company said that profits for the year ended 31 July were expected to be ahead of market forecasts.

The company’s products and services are designed to help transport operators monitor and manage their resources. Examples include data collection from road and rail infrastructure, traffic monitoring, rail crew rostering and a wide range of other specialist services.

Why I like this so much

One of the company’s strengths is that many of its services are quite ‘sticky’. Competition is limited and once a service is installed, it becomes difficult for the customer to switch to a rival provider.

In fairness, another of Tracsis’s strengths is that it seems to be very good at what it does. So customers don’t want to leave very often.

The company’s business has expanded through a mix of organic growth and targeted acquisitions. Net profit has risen from £2.1m to £3.7m over the last five years. The group has also consistently maintained a net cash balance. This rose from £15.4m to £22m last year, demonstrating the strong cash generation of this business.

After today’s gains, I estimate that the shares trade on about 25 times forecast earnings. This isn’t cheap, especially as the dividend yield is less than 0.5%. But the growth record of this business suggests to me that it should continue to deliver. Although I’d prefer to buy on the dips, this stock could still be a good long-term buy.

Defensive profits

My next stock is a small-cap engineering business whose share price has doubled over the last five years.

Cohort (LSE: CHRT) is made up of four engineering companies operating in the defence and industrial sectors. Each firm retains a high degree of independence but benefits from a network of financial support and opportunities to share information.

This conglomerate business model is unfashionable these days. But Cohort’s track record suggests to me that, with good management, it can be very effective. The group’s adjusted operating profit rose by 7% to £15.6m last year, while its operating margin increased from 12.8% to 14%.

Net cash rose from £8.5m to £11.3m and shareholders enjoyed a 33% hike to the total dividend, which was lifted to 8.2p per share.

Order book growth?

One disappointment was that Cohort’s order book fell by 25% from £136.5m to £102.5m last year. The company says this was down to delays rather than a shortage of opportunities, and expects a high level of bidding this year.

Analysts covering the stock are taking a cautious view and have pencilled in a 4% increase in earnings for 2018/19. This may not seem very impressive, but the shares currently trade on just 12.5 times forecast earnings and offer a 2.3% yield.

In my view, this valuation suggests that the stock is priced for bad news. I believe good news is more likely. If I’m right, the shares could perform strongly from here. I rate them as a buy.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Cohort and Tracsis. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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