Only 512MB RAM? WinXP generally takes close to 600MB of that, so you are already using Virtual Memory before you even fire up VLC.
The last time I ran on that little, I had issues with choppiness even on my desktop; issues that disappeared when I went to 768MB (¾ GB) and never had on my 1GB netbook. Those systems only got choppy when I ran applications. So you really need at least 1GB to do much of anything with WinXP, especially anything time-dependent like video playback.
I have run older computers with slower CPUs and a few modern low-powered ones without the problems you’re having because I made sure to give it plenty of RAM. The issue isn’t your CPU.
@koanhead Unless you are running hefty editing apps like Photoshop or AutoCAD, I find the sweet spot to be around 2GB with WinXP. 1GB will give you good performance for light work (net-surfing and stuff) while less RAM will cause problems before you are even done booting. With 2GB, you can run most apps great and the hefty ones reasonably well without passing the point of diminishing returns.