Moderna Inc has been a rock star stock this week. The company’s script saw a meteoric rise after it announced that they have made significant progress in developing a potential vaccine for COVID-19.
The immediate question popping up in your mind would be - Is MODERNA Inc Shariah compliant?
Yes, MODERNA Inc is Shariah compliant and has been so historically.
All the while since the stock was trading at $20 to it reaching a peak of $80 this week – all in just 6 months, the stock has been Shariah compliant. That’s a 4X increase in value! If you followed Islamicly, you could have benefitted from this rise.
So, what is so curious about the Shariah compliance of MODERNA Inc and other such biotechnology companies?
A quick glance at the revenue structure of MODERNA Inc and other such biotechnology companies will reveal that interest income forms a significant part of their total income. The levels of interest income in such companies was found to be way above the ‘tolerance limit’ of non-permissible incomes in a Shariah compliant company i.e. 5% of total income.
Then how come MODERNA Inc and other such biotechnology companies are Shariah compliant?
The answer lies in the application of the Shariah screening criteria as intended by Shariah scholars.
The interesting thing about all these companies including MODERNA Inc is that they are all research stage companies. They seem to have the potential of achieving medical breakthroughs to treat various ailments affecting mankind. They are currently invested in research and development of various drugs and treatment procedures which are not yet commercialized.
Hence, the revenue derived from their operating business activities is either nil or very small. Most of their funding or capital is awaiting deployment as they are yet to reach the ready to market stage. Hence earning huge interest income from deposit of such undeployed cash at banks.
With monetisiation of their research still away, this interest income forms a significant part of their total income exceeding 5% of their total income.
Treatment of interest income as per the Shariah scholars
The Shariah screening criteria is designed to allow investment in companies which derive more than 95% income from Shariah permissible business activities. Here, the income to be considered for calculating the non-permissible income threshold of 5% should be derived from 'operating activities' of the company or active areas of business. Non - operating income should not be considered while calculating the sector compliance. Interest income is derived from such activity of the company which is not in-line with the core business activity but accrue to the company passively. Hence, it is not to be considered for the sector screening of the company. But such non-operating interest income is included in the dividend purification ratio calculation.
In today's financial world, interest based banking is prevalent. Hence companies which pass the sector screening criteria as well as the financial ratios are still highly likely to be involved in placing their cash balances in banks or term deposits which accrue interest. If such a company gives out a dividend, then this interest income also forms part of that dividend. Hence dividend purification is applied to Shariah compliant stocks to cleanse the element of impure income coming from interest and other areas. Remember, non-operating interest income is included in the dividend purification ratio calculation.
This step effectively eliminates the element of interest income from your earnings received from a Shariah compliant stock. In the case of MODERNA Inc and many research stage biotechnology companies, you will notice that these companies derive all of its incomes from a Shariah permissible businesses i.e. medical research and development. But since they are research companies and have not yet reached a product stage, they have excess cash balances which are not yet deployed for commercial production purposes. Hence such cash is sitting as deposits with conventional banks earning interest.
Remember, this interest is accounted for in the Dividend Purification ratio calculation, which you can see on the premium version of the app and desktop for all such companies. Such companies are a classic case in point which fully demonstrates the intent of the Shariah screening criteria as designed by the Shariah scholars. It also demonstrates that Shariah screening is a scholar led and guided approach rather than a cursory application of their guidelines. Remember, the magic is in the sector/business screening.
Let us examine these companies over the essential question which affects Shariah compliance:
Is the company's business activity Shariah compliant? – YES, since it is a medical research activity and all operating revenues are derived from such permissible activities.
It is interesting to note that in such companies, if we consider the non-operating interest income (which is an incidental revenue), high potential companies, like MODERNA Inc will be classified as Shariah non-compliant in their growth phase. And when they are fully mature after having commercialized their research and deployed their cash for production, they will then become available to Shariah investors - all this while the business activity of the company remained the same.
At this stage the stock would have been fully valued resulting in a disadvantage for Shariah sensitive investors
But isn’t investing in these companies akin to investing in a conventional finance company as a majority of their ‘current revenue’ is derived from Interest income?
No. The key difference is that in these companies, interest income is non-operating in nature and the core operating business activity is compliant. While in a conventional finance company, the interest income is operating in nature as it is earned from the core operations of the company.
Islamicly research team has discussed this treatment of interest income with Shariah scholars who are members of various prestigious Shariah Boards such as the S&P Shariah Index, Dow Jones Islamic Markets Index and AAOIFI. The scholars were unanimously clear that the intension of the Shariah screening criteria is to exclude non-operating interest income while computing sector compliance, but include it in the calculation of dividend purification ratio.
This seems to be a big error committed by screening providers who unfortunately, have not been working directly with scholars who have set the guidelines. Further, the misunderstanding has been accentuated by the slight ambiguous wordings of Shariah Standard 21 of AAOIFI – Financial Paper (Shares and Bonds).
If we study the impact, 351 Biotechnology companies are Shariah compliant on Islamicly, which may be erroneously classified as non – compliant if the interest income is accounted as part of the 5% threshold.
The impact does not stop at the biotechnology sector, this treatment also hampers your participation in IPOs of greenfield projects in energy, mining, infrastructure and technology companies - which take time to develop and accrue revenues, while the core business is compliant. For more such cutting research, subscribe to our premium version.
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TAG: SHARIAH COMPLIANCE STOCK RESEARCH