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2 growth-and-dividend small-caps I’d buy to retire on

Shares of XP Power (LSE: XPP) are 6% higher at 2,625p late-morning after the company reported “a very strong first half.” It also said: “The board now anticipates the group’s performance for the full year will be comfortably ahead of its existing expectations.”

Back on 30 May 2008 (the significance of the date will become apparent later), XP Power’s shares were trading at little more than 200p. The tremendous gains have propelled this developer and manufacturer of critical power control components for the electronics industry into the upper echelons of the FTSE SmallCap index with a market cap of £514m.

I believe XP Power can continue to deliver capital gains in the coming years, as well as strong dividend growth for the long term. As such, this is a stock I’d buy today with one eye on a rising share price and the other on a future strong income stream in retirement.

Highly attractive

The strong first-half performance reported today came on the back of encouraging momentum in orders and revenues, as new design wins enter production, supported by a recovery in capital equipment markets and sterling weakness.

Order intake increased 52% (35% at constant currency) to £93.4m, a new record for the company. Orders were strong across all the group’s geographical regions.

Revenue increased 33% (18% at constant currency) to £80.2m and adjusted earnings per share (EPS) of 68.2p was 30% up on the same six months last year. Ahead of today’s results, analysts were forecasting EPS of 123.2p for the full year. But annualising the first-half number gives 136.4p and a price-to-earnings (P/E) ratio of 19.2.

The P/E looks highly attractive for a company with XP Power’s growth record and prospects. And I anticipate the dividend rising strongly in the coming years from today’s starting yield of 2.9%.

The time is now right

I mentioned the terrific performance of XP Power’s shares since 30 May 2008 – the date on which OPG Power Ventures (LSE: OPG) began trading on London’s junior AIM market.

Investors who backed the 60p-a-share IPO of this developer and operator of power generation plants in India – or a further placing at 93p in 2011 – are currently sitting on losses. The shares are trading at 44.5p.

Having raised £65m in the IPO and a further £60m in the placing, OPG has built its portfolio of assets from 19.38 megawatts at flotation to 750 megawatts today. Despite now being a more attractive investment proposition, OPG’s market cap is £156m compared with £173m when it debuted on AIM.

Risk and reward

Risks for this India-based business – as detailed on pages 32 and 33 of the company’s latest annual report – should not be overlooked but I believe these are more than offset by an experienced management team, the current cheap valuation of the stock, and the long-term dividend prospects.

The company is forecast to post EPS of 6.2p in its upcoming annual results (17% ahead of last year), giving a P/E of just 7.2 at the current share price and a bargain-basement price-to-earnings growth (PEG) ratio of 0.4.

Furthermore, with the board having last year set out a dividend policy, with an initial highly conservative payout ratio of 15%, there’s considerable scope for the dividend to grow strongly from a maiden yield of 2%.

Lucrative strategy

Including some high-potential small caps alongside core heavyweight holdings can be a lucrative strategy for investors.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended XP Power. 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.