Exploring Shariah-compliant approaches to equity investments

Shariah-compliant equity investing involves the selection and management of stocks in accordance with Islamic principles. Investors in Shariah-compliant stocks seek to adhere to Islamic finance principles, avoiding investments in companies involved in activities such as interest-based financing, gambling, alcohol, pork, and other non-compliant businesses.

Shariah scholars, over the past few decades, have established specific rules that guide the selection process to determine the Shariah-compliant status of a stock. These rules collectively form what is known as Shariah-Compliant Securities Screening.

What is Shariah-Compliant Securities Screening?

The Shariah screening criteria establishes guidelines for evaluating listed companies to determine their suitability for investment according to Islamic principles. This process involves two distinct levels.

Business screening

Companies with less than 5% of their operating revenue originating from the specified non-permissible sectors successfully clear the sector screening, provided that such revenue is associated with core or active business activities.

Non-permissible or prohibited activities includes:

• Adult Entertainment

• Alcohol

• Cinema and Broadcasting

• Conventional Insurance

• Conventional Financial Services

• Defense

• Gambling

• Hotels

• Music

• Operating and Non-operating Interest Income

• Pork

• Tobacco

Financial ratio screening

A listed company must satisfy three financial ratios to successfully navigate the financial ratio screening.

• Interest bearing debt/36 month average Market Cap < 33%

• Cash + short term investments/36 month average Market Cap < 33%

• Accounts Receivables/36 month average Market Cap < 49%

Should the company's performance fall below the specified threshold in all three ratios, it is considered to have successfully cleared the financial ratio screening.

Achieving Shariah-Compliant Status:

After successfully navigating through both stages of Shariah-Compliant Securities Screening, a listed company attains the status of a “Halal stock”. Having clarified the criteria for a stock to be deemed Halal, investors must now adhere to the following guidelines to ensure their full compliance with Shariah principles.

• They are not utilising leverage: No borrowed money from broker or external sources to enter into positions (i.e. positions must be fully funded by investors’ own money)

• No short selling: Investors are not allowed to sell borrowed stocks and gain from falling prices

• No gains from interest: Some brokers on the street provide interest income for investors on unused cash balances. This is not Shariah compliant.

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