SHARIAH STOCK SCREENING: THE MINIMUM YOU SHOULD KNOW

Introduction

A very important component of Islamic finance is the Islamic capital market or equity market. Very fundamental to the development of this sector is the availability of Shariah compliant stocks which Muslims can invest in. This necessitates that we have a set of criteria against which a company’s share or stock would be assessed in order to ascertain its Shariah compliance. For the sake of clarity, a Muslim may only invest in stocks that are Shariah compliant.

Generally, stock screening methodologies typically consider both qualitative and quantitative factors associated with a business entity. This short write up seeks to give an introductory exposition into the criteria usually considered in determining whether a company’s stock/share could be invested in or not. While there may be a slight variance in these criteria from one jurisdiction to another, for the purpose of this discourse, I shall be making reference to the AAOIFI shariah Stock screening criteria most of which are derivable from the Shariah Standard No (21): Financial Paper- Shares and Bonds.

Why Is This Important?

As earlier stated, a Muslim willing to participate in the capital market may only earn from investment in stocks that are halal, and this can only be made possible by ensuring that the stocks meet the sharia screening requirement. By implication, the returns/dividends from an impermissible investment are likewise impermissible in themselves. This is based on the legal maxim that “whatever is impermissible in itself, its price or income is also impermissible”.

So, what are the stock screening criteria?

Qualitative Factor

1) Main Business Activity

This concerns the core business or main activity of the company. This criterion seeks to ensure that the company’s line of business or major activity is not from the prohibited or impermissible business activities. Prohibited businesses may include line of business relating to conventional banking, insurance, gambling, trade in alcohol, weapon, pork and pork-related activities, non-halal foods and beverages, and shariah non-compliant entertainment.

If a stock passes this qualitative criterion, then it is assessed against quantitative criteria.

Quantitative Factors

2) Non-compliant Income to Total Income    

In the case whereby the total income of the company contains a prohibited income component, this should not exceed 5% of the entire income. This prohibited income usually come in the form of interest income on placements, treasury bills etc. or other activities which are not the core-business of the company. In other words, a company may still be deemed Shariah compliant, provided that these prohibited activities are not the main or core business of the company and the income from such is within the acceptable threshold.

3)   Interest Taking Deposits Ratio

This concerns the cash interest-yielding deposits of a company. This criterion seeks to ensure that the amount of deposits or cash upon which a company earns interest does not exceed 30% of the total market capitalisation of the company. The primary purpose of this criteria is to restrict a company from placing its funds in conventional instruments and banks.

4)   Ratio of Interest-Bearing Debt to Market Capitalisation

A company has two options in financing its capital structure: debt capital and equity capital. Majorly, debt capital is usually interest-bearing which means that a company would have to pay interest on the borrowed capital. This criterion seeks to discourage and restrict a company from financing its capital structure through interest bearing debts. In this regard, the AAOIFI standard specifically states that the collective amount raised as loan on interest- whether long term or short-term debt- does not exceed 30% of the market capitalisation of the total equity.

5)   Ratio of Illiquid Assets to Total Assets

For the stock of a company to be tradeable, the total market value of illiquid (tangible/fixed) assets must be greater than 30% of the market value of the total assets. In other words, the major bulk of the company’s total asset should be fixed asset as opposed to receivables and cash which are current/liquid assets.

How do I know if my stock porfolio Is Shariah Compliant?

You can determine that yourself using any of the acceptable stock screening Indices some of which are AAOIFI index, Financial Times Stock Exchange (FTSE) Global Islamic index, Kuala Lumpur Stock Exchange Islamic Index (KLSEII), and Dow Jones Islamic Market Index (DJIM).

In Nigeria for example, we have the Nigeria Stock Exchange Lotus Islamic Index launched in 2012. This index represents Shariah compliant equities listed on the stock exchange and which consists of about fourteen (14) Shariah compliant equities as at mid-year 2020. 

Conclusion

The launching of various stock screening indices has assisted in boosting Muslim’s participation in capital market by identifying Shariah compliant stocks. While these indices and how they are calculated may vary from one jurisdiction to another, it cannot be gainsaid that this variation is a true reflection of flexibility within the Islamic finance industry.

Finally, every Muslim is encouraged to ensure that he or she invests only in stocks that are Shariah compliant and I hope by now you have a sense of how you can identify those stocks in your portfolio that are not shariah compliant.