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and finally i think let's go back to my upbringing or at least my early career again um we're all very subject to recency biases the first thing i would say if we're not careful and people talk about inflation a lot now because it's an issue in their minds and they're not wrong to think about it i'm not suggesting they are for a moment um but you need to get it in perspective um i started working 1974 uh late 1974 and my first full year in work was 1975.
um i wonder if i give your uh your listeners a moment to guess no googling you lot uh what the cpi went up by in 1975 in the uk 24 wow wow yeah now i lived through that if you went back to things you learned in the past i've seen real inflation in action and i can tell you how do i see inflation planning out i simply don't know i mean i don't feel that i've got enough insight into this to say however i'm not totally pessimistic about it although we've clearly got inflation at the moment the reason i'm not um uh that pessimistic question is if you look back at the facts always a good place to start you will find there's not any positive correlation or strong positive correlation between commodity prices and retail prices um in fact there are quite strong negative correlations in a number of commodities over time and the reason for that this comes back to how do you because you said well terry about how do you select companies report is the first impact of inflation is not on consumers it's on companies you know we don't buy commodities you don't go and buy commodities you buy things that are being processed by companies about even when you buy nice well i buy oil no you don't you buy gasoline or diesel you don't buy oil um when you buy food it's it's agricultural commodities which are being processed to to deliver to deliver to you or it's electronics things that have been processed in terms of resources in terms of cobalt and so on lithium to make electronics the first impact is on companies it's not on and that may work through companies into consumers in the end and then we'll have a real inflation which means this if you're trying to think of what company do you want to own an inflation period own one with a high gross margin gross margin is the difference between revenues and cost of goods sold companies take in stuff they take in ingredients components services do something to turn them into a product and sell it to you and uh that's your gross margin difference between those two things um the average gross margin in our portfolio is 60 which is to put it in english for you they make things for four and they sell them for 10.
the average on the index is 40 which is to say they make things for six and they sell them for 10. now if you're going to have a period of inflation where the the cost of goods goes up by 10 right it's clearly a lot better if it goes up from 40 to 44 than 60 to 66 basically the impact on your profitability which was lower in any event in the other companies is much greater high gross margins are a buffer for companies um and they are also a measure of their pricing power i mean the best gross margin companies in the world are people in the software business and people in goods where the cost of goods are very low things like cosmetics and in their case i think you could have inflation and it wouldn't matter at all basically so that's where we look at the one thing where inflation i think will have quite a lot of impact negatively on not just our companies but the market in general but probably disproportionately high on us and you touched upon it is if there is a a big pickup in an inflation which persists and that's the other thing it's not much just whether we've got inflation we've obviously got very unusual circumstances at the moment in terms of covid the pandemic the recovery and the supply chain i don't think we'll know whether we've got secular inflation until we've lacked that but if it does persist and requires central bank action interest rates will go up and when interest rates go up valuations come down basically so i i'm not when you think about our portfolio you you i regard it as a two-stage question terry if there is inflation are you worried about the fundamentals of your company not much and certainly not compared with the market are you worried about valuation yes quite a lot i think it could have quite a profound effect on valuation if inflation takes hold persists and the central bank
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