Sharia Stock Screening
The fundamentals and financials of a company are evaluated by qualified sharia scholars and once it’s found to be within the required sharia norms, its certified as sharia compliant. Internationally there are several organisations which provide sharia compliance evaluation and certification. Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI -headquartered in Bahrain) is the apex governance and standard setting body for Islamic institutions across the world. In India Taqwa Advisory and Sharia Investment Solutions (TASIS – Mumbai, India) is India’s premier institution providing sharia screening and advisory services.
Basically, Sharia Screening of stocks is a 5-step process.
Based on the core business activity, review total universe of companies listed with the stock exchange. On the basis of the review filter out those companies which are engaged in non halal or non-acceptable business activities namely;
• Financial institutions dealing with Interest (Riba)
• Rearing and trade of Pork products
• Alcohol and Tobacco
• Production and distribution of weapons of mass destruction
• Adult content
• Gambling, Lottery and Casinos
After removing companies with non-compliant business activities the rest of the companies are examined for compliance in financial ratios, as certain ratios may violate compliance measurements. The 3 areas of focus are leverage, cash and the share of revenue derived from non-compliant activities
Debt to Total Assets <=25%
Assessment of Leverage Ratio
The total (long-term and short-term) interest-bearing debt liability must not exceed 25% of the company’s total assets. Such a limit has been fixed because 1/3rd is considered abundant in the Qur’an.
In this step we filter out companies which have debts to total assets in excess of 25%.
Cash + Receivables to Total Assets <=90%
Companies having cash and cash equivalent exceeding 90% of their total assets as per book value need to be filtered out in this step.
The shares of a company are negotiable as per sharia only if the company’s receivables are below the 90% level. This is because if the majority (more than 90%)of the assets of a company are in liquid form, then it cannot be purchased or sold, except on par value.
Interest Based Investment to Total Income <=3%
In this step if the interest income and other non-permissible sources of income are more than 3% of the company’s total income then those companies need to be filtered out.
Ongoing review and purging
Even once the company is shariah Complaint, the current /latest financials of the company is reviewed periodically and any impure or prohibited income earned due to interest income or engaging in prohibited activity if any in the due course need to be accounted as impure income. Purging(purification) is one of the requirement for shariah compliant investment. The impure income so earned needs to be given away as charity to cleanse the wealth.
We need to keep in mind the fact that any form of speculative trading, swing-trading, margin-trading, day-trading, short-selling or trading in derivatives is prohibited.
Sharia compliant shares in India
India has the largest number of Shariah-compliant stocks in the world. There are more than 1000 Shariah-compliant stocks listed on BSE and NSE. Of this more than 150 are continuously Shariah-compliant for more than 5 years. The largest sectors include Software, Automobiles, Capital Goods, Construction and Infrastructure, Drugs and Pharmaceuticals, Consumer Durables, FMCG, Telecommunication, Oil and Gas.
The aggregate PAT (Profit After Tax) to Total Income ratio of the all listed stocks is 7.5% as compared to 8.7% for Shariah compliant stocks. It clearly proves that although the universe of all listed stocks is large as compared to that of Shariah compliant stocks, but in terms of profitability it ranks below the Shariah compliant stocks.
Shariah compliant share investment avenues in India
Tata ethical, Taurus ethical and Reliance ETF Shariah BeES mutual funds are Shariah compliant investment options in the mutual fund segment. These funds are indexed against Nifty-50 Shariah, NSE 500 Shariah and S&P BSE 500 Shariah respectively.
Tata ethical and Taurus ethical mutual funds are actively managed funds, while Reliance ETF Shariah BeES is a index based fund which tries to reflect composition of Nifty-50 Shariah.
Nifty-50 Shariah, NSE 500 Shariah and S&P BSE 500 Shariah are Shariah compliant indices listed on NSE and BSE stock exchange.