Earning profits in the stock market is important, but for a Muslim, it is equally important to ensure that the income is earned in a Shariah-compliant way. Before buying shares of any company, we need to understand what the company does, where its income comes from, and how it manages its finances.
Some companies may look completely fine from the outside. However, a closer look at their business and financial reports may reveal issues that need careful attention.
At IslamicStock, a company is not declared Shariah-compliant simply because of its name, popularity, or industry. Its core business, sources of income, interest-based loans, assets, and investments are examined in detail.
Let us understand the main principles used in IslamicStock’s Shariah screening process and why some companies are classified as Mute or Doubtful.
1. Six Basic Principles of Shariah Screening
1.1. Core Business of the Company
Verifying the company’s actual operations is the first step.
The company is categorized as non-compliant if its primary business is prohibited by Shariah, such as trading in alcohol, gambling, interest-based businesses, or anything related to pork.
To put it simply, the first stage is to determine whether or not the company’s primary operation is allowed.
1.2. Limit on Non-Compliant Income
Sometimes, a company’s main business is permissible, but it may also earn some income from non-compliant sources. For example, it may receive interest on money deposited in a bank.
According to the criteria followed by IslamicStock, non-compliant income should not exceed 5% of the company’s total revenue.
Even when this income remains within the permitted limit, the corresponding portion of the profit must be given to charity without the intention of earning spiritual reward.
1.3. Limit on Interest-Based Loans
The next step is to check how much interest-based debt the company has taken to run its business.
According to IslamicStock’s screening criteria, the company’s interest-based debt should not exceed 33% of its total assets.
1.4. Illiquid and Fixed Assets
A company should not consist only of cash or assets that can easily be converted into cash. It should also have real business assets, such as land, buildings, plants, and machinery.
According to IslamicStock’s criteria, illiquid assets should make up at least 20% of the company’s total assets.
1.5. Net Liquid Assets Compared with Market Capitalization
At this stage, the company’s net liquid assets are compared with its market capitalization, which is the total market value of its outstanding shares.
Under Shariah principles, certain rules apply when exchanging money for money or assets that are treated similarly to money.
Therefore, according to IslamicStock’s criteria, a company’s net liquid assets should not exceed its market capitalization.
1.6. Checking Non-Compliant Investments
Companies may invest their surplus funds in other places. It is important to check where this money is invested.
For example, a company may invest in interest-bearing bank deposits, conventional bonds, or non-compliant funds.
According to criteria, the company’s non-compliant investments should be less than 33% of its total assets.
2. Is Checking Financial Ratios Enough?
No. Checking financial ratios alone is not enough to determine whether a company is Shariah-compliant.
Even if a company meets the required financial limits, its products, services, and business activities must also be examined.
For example, a company may not directly engage in any non-compliant activity, but it may provide products or services to another company whose main business is not permissible under Shariah.
In such cases, it is important to understand the nature of the relationship and how closely the company’s products or services are connected to the non-compliant activity.
Two important concepts are considered in Islamic jurisprudence:
- Direct assistance in sin (I’anah ‘alal Ma’siyah): Directly helping someone carry out a non-compliant activity.
- Indirect involvement (Tasabbub): Being an indirect cause or means connected to a non-compliant activity.
These two situations may have different Shariah rulings. Therefore, the nature of the company’s products, services, and their actual use must be carefully examined.
This is one of the reasons IslamicStock uses additional classifications, such as “Doubtful” and “Mute,” for certain companies.
3. What Does Doubtful Status Mean?
Some companies have significant Shariah-related concerns regarding their business activities or sources of income. Such companies may be classified as doubtful.
Example: Hotel Industry
Some hotel companies earn a large portion of their revenue from food and beverages. These may include non-halal meat, alcohol, and other intoxicating products.
However, their financial reports may not provide a separate breakdown of the income earned from these products or services.
As a result, it becomes difficult to determine whether their non-compliant income is below or above the 5% limit.
If the available information creates a strong concern that the non-compliant income may exceed the prescribed limit, the company may be classified as doubtful.
In simple words, “doubtful” means there is a significant Shariah-related concern about the company that cannot be ignored.
4. What Does Mute Status Mean?
Some people assume that a company classified as Mute has not been researched or that its data is incomplete. However, this is not always the case.
Some company-related matters are complicated and require careful Shariah analysis before a clear conclusion can be reached.
For example:
- A company may be connected to a non-compliant activity, but the extent of that connection may not be clear.
- Its financial reports may not separately disclose the income earned from a particular activity.
- The matter may involve complex Islamic jurisprudence or differences in scholarly opinions, making it difficult to reach a definite conclusion.
In such cases, the company may be classified as a mute.
In simple words: “Mute” means the matter involves certain complexities that make it difficult to assign a clear Shariah classification.
Investors should understand the nature of the issue and, if needed, consult a trusted Mufti or Shariah advisor before making a decision.
Conclusion
Shariah-compliant investing is not just about checking a company’s name or financial ratios. It requires a proper understanding of the company’s business, sources of income, interest-based debt, assets, and investments.
IslamicStock’s screening process examines six important areas: the core business, non-compliant income, interest-based debt, illiquid assets, net liquid assets, and non-compliant investments.
In addition, the company’s products, services, and connection with non-compliant activities are also examined.
When the facts are clear, a company can be classified accordingly. However, when important details are unclear or a matter involves complex Shariah considerations, classifications such as “doubtful” or “mute” may be used.
The purpose of these classifications is to give investors a clearer understanding of the issues involved and help them make informed decisions rather than investing without proper consideration.
Remember: Halal investing is not only about earning profits. It is also about making a sincere effort to ensure that our earnings follow Shariah principles. Understanding a company’s business and financial activities is an important step towards making more informed investment decisions.