2 micro-cap stocks I've added to my watch list

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Brain

The small-cap effect is one of the best known phenomenons in investing. Simply put, smaller companies have been shown to generate substantially better returns than larger companies over the long term thanks to their ability to grow earnings and profits at a rapid pace. Combine this with the beauty of compounding and it's quite possible for dedicated investors to turn an initially modest amount of money into a small fortune. Better still, this tendency is even more pronounced the further down the market spectrum you go. Pick the right micro-cap companies and early retirement might be possible sooner than you think. 

Of course, this all comes at a cost of increased volatility, inevitable periods of underperformance and higher capital risk. That's why it's hugely important to thoroughly research any potential investments before taking the plunge. Here are two micro caps I've recently added to my watch list.

Top performer

Over the last 12 months, shares in £71m cap veterinary pharmaceutical producer Animalcare(LSE: ANCR) have climbed from 58%. Not many constituents of the FTSE 100 can make such a claim.

Last week's interim results showed that the company continues to perform well. Thanks to excellent performance from its exports business, revenue from Animalcare's medicines group rose 17.2% to £5.37m over the six month period.

Currently trading on a price-to-earnings (P/E) ratio of 22, this business won't appeal to all investors, particularly those who scour the market for value. A 2% dividend yield, while easily covered by earnings, is also significantly less than you could get from merely following the main market through a low cost index tracker. While your capital can still fall in value, the latter also avoids stock-specific risk that comes with investing in single companies.

Nevertheless, with new products set for launch in the next few months, I think the party is only just getting started for Animalcare's investors. The defensive nature of companies working in veterinary services also make it a good stock to hold as we approach Brexit.

Growth star

As someone who enjoys reading up about the latest psychological research, I'm unashamedly biased when it comes to reflecting on the merits of investing in a company that offers advertising solutions based on the principles of social science.

A great example of how micro-caps can turbocharge your wealth, shares in Brainjuicer(LSE: BJU) once traded as low as 87p. £5,000 invested in the company at the height of the financial crisis in 2009 would now be valued at well over £40,000 today, excluding reinvested dividends.

Recent results from £90m cap suggest this kind of performance can continue. In 2016, the company achieved 24% revenue growth (15% in constant currency), a 38% rise in pre-tax profits and a 33% rise in earnings per share. Over the last year, its share price has soared over 163%.

With £7.75m cash at the end of December and no net debt, Brainjuicer boasts the sort of balance sheet I look for. A P/E of 17 isn't that demanding either, particularly for a business generating the high returns on capital that it has over the last few years.  

Of course, no company is perfect. Perhaps the biggest question mark surrounding Brainjuicer is its limited revenue visibility -- openly acknowledged by management. A yield of less than 1% will also put off those investing for income. Nevertheless, as a long-term investment, this company ticks a lot of boxes.

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Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.