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Invest With a Healthy Dose of Skepticism

I've always believed that you should know a company cold before you invest in it. Nonetheless, once you have all the reasoning and data you need, you should still arm yourself with a little skepticism. No amount of research and homework can completely eliminate risk when investing in your company of choice -- especially if you take its leaders' words at face value.

Paul Krugman collected some dubious comments from Robert Toll, the founder and CEO of Toll Brothers (NYSE: TOL  ) , in an Aug. 25, 2006, New York Times piece titled "Housing Gets Ugly." Back in 2005, several years into the remarkable housing boom (and before its subsequent pop), Toll waxed euphoric about the housing industry:

We've got the supply, and the market has got the demand ... it's a match made in heaven. Why can't real estate have a boom like every other industry? Why do we have to have a bubble and then a pop?

But by 2006, and Toll had a sudden change of heart. The real estate meltdown was "unlike anything [Toll] had seen," Krugman wrote, and the deterioration in home sales persisted, despite the lack of any "macroeconomic nasty condition."

Was Toll being misleading in his 2005 comments? I seriously doubt it. He built one of the most successful homebuilders in the country from the ground up, and longtime shareholders have gotten rich from his efforts. Along with NVR (NYSE: NVR  ) , Toll Brothers is one of the only homebuilders that has still managed to produce a profit. Investing in either of these firms will likely reward patient investors over the next five years or so.

Yet despite Toll's cheery comments back in 2005, according to Securities and Exchange Commission filings, he was selling millions of dollars of Toll stock, even as he praised the long-term economics of the housing industry. By citing Toll's remarks, I'm not trying to single out any particular company or industry -- I actually think Toll Brothers has one of the better management teams in the business. Instead, I'm suggesting that Foolish investors take any comments from company insiders, and especially CEOs, with a healthy dose of skepticism.

Never ask a barber if you need a haircut
While most CEOs might be poor capital allocators, they're usually great at making sales. Their goal is to keep everyone interested in their companies, and they can't achieve that by suggesting that their stock price -- or their industry -- might be due for a downward correction. As Berkshire Hathaway's (NYSE: BRK-A  ) (BRK-B) Warren Buffett says, "Never ask a barber if you need a haircut."

It's usually best to avoid getting information from company management when analyzing a company. Ben Graham avoided speaking with management because he already knew their answers. What are the odds that if you call Chipotle (NYSE: CMG  ) today, whoever you reach will simply tell you to sell or avoid the shares because their current price implies an unsustainable long-term growth rate? Chipotle is an excellent company, but that doesn't equate to an excellent investment.

Much like investing with a margin of safety, adopting the right amount of skepticism is one strategy no investor should avoid.

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10/25/2016 4:01 PM
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