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Shariah Guidelines for Trading and Investment in Stocks

Stock changes Shariah compliance? Source: blog.islamicly.com

Before we start discussing on Shariah-Compliant stocks, let us brief about Shariah.

Shariah is a law, a guide or a principle in Islam for the people to follow and to lead their lives accordingly. Shariah is an Islamic Law and way of life. We will discuss here only a part of Shariah finance that is Shariah Compliant Stocks.

Shariah finance is a key pillar of Islam that has to be followed by Muslims. This is also mandatory that each and every transaction carried out must be in accordance with the principles of the Shariah Law.

Shariah Compliant stock is one that complies with the Sharia standards.

What is Shariah Guidelines for Trading and Investment in Stocks?

The first question arises in our mind whether the stocks listed on stock exchanges are allowed for trading in Islam?

The answer is yes!

Any stock listed on any stock exchange is allowed for trading if the stock complies with the Shariah principles set out by Renowned Shariah Scholars.

The second question arises is, what is the guidelines and principles for Investments in accordance with Islam. Islam prohibits interest, sales of alcohol, sales of pork, conventional banking & Insurance and other activities against Shariah Law.

Finding companies which are not involved in activities prohibited by Islam is almost impossible. Thus Shariah scholars have set up norms and standards to screen stocks for Shariah-compliant investments.

What is Shariah Stock Screening?

Shariah screening is a process of screening stocks in accordance with the Shariah standards developed by Shariah scholars. Any stock dealing with prohibited activities by Islam is out from Shariah Compliant investments.

Process of Stock screening is based on two main criteria.

One is sector screens and another one is accounting screens

What are the Prohibited activities?

List of activities and business prohibited by Islam is enumerated below;

1- Conventional Banking & Insurance
2- Conventional financial & Capital Market
3- Interest bearing investments in shares and debts
4- Sales of pork, Alcohol and tobacco, music CDs
5- Adultery & pornography
6- Advertising
7- Media and entertainment

Any company involved in the above activities and the revenue from them exceeds 5% is out for investment.

If the revenue from such activities is below 5% of total income, then the stock will be further evaluated for Accounting Ratios.

What are the accounting Ratios for Shariah Compliant Investments?

The accounting Ratios are nothing but to limit the interest-bearing debts and investments.

As mentioned earlier, Islam does not allow a small portion of investments and liabilities involving interest but in the current fashion, this is hard to find such companies which are free from such elements.

Thus renowned Shariah scholars and experts in Islamic finance have set us accounting ratios to limit the interest-bearing investments as well as borrowings.

There are 4- 5 shariah screening criteria but the famous and widely accepted criteria by most of the scholars in the industry are S&p Shariah Screening criteria

The accounting ratios for S&p Shariah Screening criteria are based on Leverage compliance and Cash Compliance

Leverage Compliance

i- Debt / Market Value of Equity (36month average) < 33 %

Cash Compliance

i- (Cash + Interest Bearing Securities) / Market value of Equity (36 month average) < 33%

ii- Accounts Receivables / Market value of Equity (36 month average) < 49 %

If any stock passes the sector screens as well as the financial screens, the investment in such stock is perfectly allowed.

To know more about Shariah-compliant investments, how to find a shariah compliant stock and where you can find a shariah compliant stock, please be tuned to it for the next blog.

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