Shariah Principles
HalalStocks.Co Pty Ltd has a robust investment screening process which has been reviewed and approved by Amanah Advisors (www.amanahadvisors.com) for Shariah compliance. The stock market investment criteria are governed by the following two screenings:
- Business Activity Screens
- Financial Screening Criteria
1. Business Activity Screening
The below broad categories are excluded by default due to the potential of being problematic or impermissible as judged by what’s common practice in their industries. At our discretion, any company that deals in un-Islamic products or services may be excluded from our universe of equities.
Financial Services -
- Asset Management
- Banks
- Banks - Diversified
- Banks - Regional
- Mortgage Finance
- Capital Markets
- Capital Markets
- Financial Data and Stock Exchanges
- Insurances
- Insurance - Life
- Insurance - Property and Casualty
- Insurance - Reinsurances
- Insurances - Specialty
- Insurances Brokers
- Insurances - Diversified
- Diversified Financial Services
- Shell Companies
- Financial Conglomerates
- Credit Services
Gambling
- Leisure
- Resorts and Casinos
Beverages and Alcoholic Drinks
- Brewers
- Distillers
- Wineries
- Packagers
- Wholesalers
- Transporters
- Sellers including pubs
- Bars
Pork, meat related and Doubtful food industries:
- Confectioners
- Farm Products
- Packaged Foods
- Food Distribution
- Grocery Stores
Tobacco Industry
Media and Entertainment:
- Producers, Distributors and Broadcasters of music, movies, tv shows
- Advertising Agencies
- Publishing
- Broadcasting
- Entertainment
Aerospace and Defence
2. Financial Screening Criteria
Interest-bearing debt screens
Entry criteria: - Less than 20% of (Enterprise Value + Cash Amount)
Exit criteria: Greater than or equal to 30% of (Enterprise Value + Cash Amount) with a 3 month grace period.
The entry criteria is more strict as the strategy being employed is buy-and-hold. As such, a 20% entry ratio reduces the risk of the stock turning non-compliant during the holding period.
Interest earning assets screens
- Entry criteria Less than 20% of (Enterprise Value + Cash Amount)
- Exit criteria: Greater than or equal to 30% of (Enterprise Value + Cash Amount) with a 3 month grace period.
Impermissible Revenue < 5% of Total Revenue
3 Month Grace Period:
Given the volatility of stock prices due to market volatility and market dynamics, scholars have mentioned that a grace period of 3 months can apply when holding shares. This means that if a stock was compliant and then suddenly shows up as non-compliant due to an impact on its market cap, enterprise value etc without a major change on its capital structure, then this may be transitory and momentary. As such, a grace period of 3 months can apply for stabilisation, saving investors, fund managers from having to continuously liquidate and repurchase the same stock over and over again.
At Halal Stocks, stock compliance is checked on a monthly basis. If a stock in the portfolio goes non-compliant during the holding period for three consecutive months, then it is removed from the portfolio and users are notified of the non-compliance in our monthly communications.
If a stock remains non compliant for 3 consecutive months, all holdings of that company must be sold. If the stock price has risen since the initial non compliance then the difference between the sell price and the price at the time of initial non compliance must be given away in charity.
Any dividend earned during the time the stock is non-compliant should be disposed of in charity.
3. Juristic reasoning behind the criteria
Some of the jurisdictions reasoning behind our business activity screening is described below, courtesy of Mufti Faraz Adam of Amanah Advisors.
Financial services
The majority of conventional financial services involve interest. Interest is categorically prohibited in the Qur’an. The Qur’an says:
“O you who believe! Remain conscious of Allah, and give up all outstanding gains from usury, if you are [truly] believers; for if you do it not, then know that you are at war with Allah and His Messenger. But if you repent, then you shall be entitled to [the return of] your principal. You will do no wrong, and neither will you be wronged. [Surat Al-Baqarah, 278-279]
Usury is also discouraged in the Bible (see Exodus 22:24, Leviticus 25:36-37, Deuteronomy 23:19, Luke 6:35) and was condemned by the Greek philosophers Plato and Aristotle among others.
Gambling
The Qur’an states:
“They ask thee concerning wine and gambling. Say in them there is great sin and some benefit for men. The sin is greater than the benefit.” [Qur’an 2:219]
“O believers! Intoxicants and gambling, worshipping stones and divination by arrows are impure, of Saytan's handiwork: refrain from such abomination so that you may prosper.” [Qur'an 5:90]
Beverages and alcohol
The Qur’an states:
“Satan wants only to excite enmity and hatred between you with intoxicants (alcoholic drinks) and gambling, and hinder you from the remembrance of God and from The Prayer. So, will you not then abstain?” [Qur’an 5:90-91]
Abdullah Ibn Umar narrates that Prophet Muhammad (peace be upon him) said: “Every intoxicant is Khamr and every intoxicant is unlawful (Haram)…” [Sahih Muslim]
Pork and meat related industries
Pork is expressly forbidden in the Qur’an:
“He has forbidden you Maytah (dead animals), and blood, and the flesh of swine…” [Qur’an 2:173]
Tobacco
It is a factual reality that smoking harms one’s health. We have been instructed by God to not destroy ourselves with our own hands and actions:
“And make not your own hands contribute to (your) destruction.” [Qur’an 2:195]
Some scholars have argued that tobacco qualifies as al-Khabā’ith (filthy substances) which was prohibited in the following verses:
“He permits At-Tayyibāt (i.e. all good and lawful as regards things, deeds, beliefs, persons and foods), and prohibits al-Khabā’ith (i.e. all evil and unlawful as regards things, deeds, beliefs, persons and foods) [Qur’an 7:157]
Media and entertainment
Pornography and illicit relationships have been deemed shameful and indecent in Islamic teachings. The following verses in the Qur’an explicitly prohibit such activities:
“Surely God enjoins justice, kindness and the doing of good, to kith and kin; and He forbids all that is shameful, indecent, evil, rebellious and oppressive." [Quran 16:90]
"And do not come near to adultery, for it is a shameful deed and an evil, opening the road (to other evils)." [Qur’an 17:32]
Weapons and Military Industry
The classical jurists prohibited the sale of weapons in the time of warfare. As such, contemporary scholars have warned against trading in weapons which are commonly used indiscriminately and with mass destruction.
Notes to Financial Screening
These financial ratios are based on scholarly reasoning. In the late 1980s and early 90s, the scholars reviewed the issue of investing in listed equities. The majority of the listed companies had interest-bearing debt and interest receivables. Thus, the scholars saw that there was Umūmul balwā (widespread exposure and difficulty) which cannot be resisted unless one adopts a nomadic approach to business and finance. Therefore, the scholars at the time were of the view that there should be some allowance and concession to invest in equities which are exposed to minimal impure income on the condition that the Muslim investor does not benefit from or keep such impure income. Most listed equities in the west keep deposits in interest-bearing business accounts and cannot find alternatives. Likewise, many of the listed companies are founded and directed by non-Muslims, which use interest-based lending for financing. Hence, scholars analysed the primary and secondary sources to identify a benchmark to differentiate between excessive impure income exposure and non-excessive. However, the challenge they faced was determining an acceptable threshold. Some proposed 49%, as that is the final number to remain a ‘minority’. However, others argued that Prophetic narrations have considered one-third as being sufficient and excessive, for example the following narration:
Narrated by Sad bin Abi Waqqas (r.a): “I was stricken by an ailment that led me to the verge of death. The Prophet came to pay me a visit. I said, ‘O God’s Apostle! I have much property and no heir except my single daughter. Shall I give two-thirds of my property in charity?’ He said, ‘No.’ I said, ‘Half of it?’ He said, ‘No.’ I said, ‘One-third of it?’ He said, ‘You may do so, though one-third is also excessive.” [Bukhari Volume 4, Book 51, Number 5]
Similarly, Imam Malik and the Maliki school have considered one-third as excessive in other areas of Islamic law too. Based on the above, scholars felt that there is a reference to excessiveness in the sacred text and in Islamic law which was quantified as one-third. Thus, scholars settled on one-third as a benchmark for excessiveness. Although 30% is not one-third, 30% was seen as a reasonable standard just below one-third to prevent the “excessiveness” from being within touching distance. Although this is contemporary scholarly reasoning, since then, the majority of scholars have adopted this view. This view has gained further strength and is now an industry-based standard with widespread scholarly acceptance and approval.
The use of 20%.
We at HalalStocks.co provide investment models which implement long term buy and hold strategies. Although conventional Shariah screening criteria uses 30-33% as a threshold, we have chosen to use a more conservative 20% threshold at the time of purchase to help mitigate against a company going out of compliance during the minimum holding period (typically one year or more). The exit criteria is the standard 30% denominator with a 3 month grace period.
Use of Enterprise Value as a denominator
Shariah screening criteria use the overall value of a company to determine concessional levels of interest-bearing earnings, interest-bearing debt and impure income. Generally, the use of market capitalisation and book value of assets are considered. Although these are acceptable methods and globally approved by the scholars, there may be another denominator that Shariah screening criteria can use in the form of Enterprise Value (EV). The formula for EV is as follows:
Enterprise Value = [market value of common stock or market cap] + [market value of preferred shares] + [total debt (including long and short-term debt)] + [minority interest] – [total cash and cash equivalents].
In simple words, enterprise value is the total acquisition price of a company as it calculates the full cost of gaining total control over the company’s assets. It is the gross acquisition cost of a company. We feel this is a more holistic estimate of the value of a company vs Market Cap or Total Assets alone as it captures the effect of those who are higher on the capital stack than the common shareholder. It takes into account the claims of creditors, preferred shareholders and minority interest holders on the company. These are claims on the company that must be paid out before the shareholders of the company can lay any claim on the assets of the company.
However, it is considered that a company with more cash and less total debt in its balance sheet will carry an enterprise value less than its market capitalization. In contrast, a company with small cash and more debt on the balance sheet will have an enterprise value higher than its market capitalization. The spirit of EV is the net acquisition cost of a company, i.e. to get total ownership of a company, you would: buy all the common stock, all the preferred stock, pay off all the debt and in return you would have access to all the cash in the company. Thus, the subtracting of the cash value. Companies with large cash values will have lower EV than their market cap and in some extreme cases, companies can have negative Enterprise Value - i.e their cash value exceeds their market cap + debts.
In order to address this, we add the total cash and cash equivalents back to the denominator for the purposes of Shariah Compliance Screening.
Financial Screening Denominator:
Enterprise Value + Total Cash and Cash Equivalents = [market value of common stock or market cap] + [market value of preferred shares] + [total debt (including long and short-term debt)] + [minority interest]
Zakat
Zakatable % for stocks held for capital appreciation (no trade) by the HalalStocks Algorithmic investment system is calculated as:
Zakatable % = Current Assets / Total Assets * 100
Dividend interest purification ratio
Dividend interest purification ratio is calculated as income from interest divided by total revenue.