Financial markets plays a vital role in contemporary economic systems by encouraging and allocating the savings of investors to invest in the stock market which helps economic development by transferring funds from categories, whether individuals or companies, which have financial surpluses and known as lenders to categories suffering from deficits and called borrowers. Stock market is divided into several sectors such as real estate, services, financing, insurance, petrochemicals, construction, transport, cement, industry, agriculture, hotels, tourism, communications, technology, retail and food. Companies shares are listed in stock exchange based on the sector to which the company activities belong; regardless of the compatibility of the activities of such companies with Shariah. Let’s learn how to screen Shariah compliant stocks.
Shariah Compliant Stocks require due care in the selection process. The Stock exchange clients vary based on their goals, there are investors who invest in companies shares which they believe in their success based on the strength of its financial position, level of profitability and reliance on several other financial indicators. They retain such shares for long periods, and usually ignore the daily price fluctuations of market prices. The other type of clients called speculators and they focus on seizing opportunities of short term price movements, unlike investors, to achieve quick gains regardless of company performance.
Although the primary goal from investment in shares, either for investors or speculators, is to maximize profits, preservation of capital and ensure a balance between liquidity and profitability, there are other targets for investors who want to buy and trade in Shariah compliant stocks represented in obeying God and his Messenger in a way serving individual and public interests by investing in legitimate activities (halal) only and avoid forbidden activities.
Accordingly, companies shares listed in stock exchange can be legitimately reclassified into three sections: the permissible companies, forbidden companies and mixed companies. Permissible companies defined as companies with documents stipulating to comply with the provisions of Shariah, or companies that actually apply all provisions of the Shariah although its documents do not actually stipulate the necessity to adhere to Shariah. Forbidden companies, their main purpose is to run illegitimate activities such as dealing in usury (riba) conventional banks, finance companies and traditional insurance companies; production, bottling and selling wines; trade in pork; nightclubs, drugs, gambling, sports betting, tobacco products and weapons. Mixed companies are established for legitimately permissible purposes, but they are dealing in usury with banks, either by borrowing or lending which resulting in mixing of permissible and forbidden operations. And despite the different opinions of Shariah scholars between permitting and prohibition of acquiring and trading shares of these companies, we will review the controls which regulate dealing with such kind of companies in case the investors or portfolio managers want to include the shares of such companies in the securities portfolio.
The bases of selecting mixed companies to acquire and trade its shares
An investor, broker, agent or portfolio manager can create a basket of companies shares that will be invested by doing a preliminary survey of financial market including various sectors to exclude “forbidden companies” of which activities and objectives are incompatible with Shariah and focus on “permissible companies”. Whereas, the shares of “mixed companies” shall be selected depending on “Financial Screening” which depends on analyzing the latest audited financial statements, in addition to reviewing the articles of association of the company based on financial papers Shariah standard of shares and bonds issued by Accounting and Auditing Organization for Islamic Financial Institutions in Bahrain “AAOIFI”. According to ” AAOIFI”, the following four controls shall be followed; (First) The articles of association of the company shall not stipulate, in company objectives, to deal in usury or trade in wines or pork products and similar forbidden activities; (Second) The total amounts borrowed by way of usury shall not exceed 30% of market capitalization of the corporation; (Third) The total amounts deposited by way of usury shall not exceed 30% of market capitalization of the corporation; (Fourth) Total forbidden income shall not exceed 5% of company total income.
Although relying on “AAOIFI” is prevalent, such percentages may vary occasionally based on doctrinal opinion issued by Shariah Supervisory Board of financial market or Islamic investment funds (Shariah Compliant Stocks). For example, the financial screening of Dow Jones Islamic Index depends on that the percentage of debts, cash and interest-bearing securities, accounts receivables (each separately) shall be less than 33% comparing to market capitalization. Individual investors can resort to the broker or portfolio manager to obtain a list of companies of which shares can be regularly acquired and traded, whether they are “permissible or mixed companies”.
Continuous Shariah Monitoring of Shariah compliant stocks
Investment in the financial markets generally and “mixed companies” particularly needs an effective control system and monitoring financial ratios, in addition to reviewing the articles of association of companies regularly, especially with quarterly profits announcement where permitting the investment in such companies does not mean necessarily that the company will continue to work within the permitted legitimate limit, as internal or external variations may happen leading to a change in company internal policies or processes resulting in exceeding the stated percentage. So as the investment in such companies will become forbidden according to Shariah. Positive critical changes can also happen in forbidden companies which may lead to its reclassification to be in the list of permissible or mixed companies. There is no doubt that the analysis of financial statements, company data and Board decisions require special skills and experiences in financial analysis which may not be available among the crowd of investors, in such case, the resort to the broker or portfolio manager will be the perfect solution to ensure remaining of mixed companies within Shariah permitted ratios and not changing the classification of “permissible companies” to “forbidden or mixed companies”. In case, it is assured that “mixed companies” are no longer within acceptable ratios during the holding period, such investment shall be left.
How to purify profits achieved from mixed companies shares
There are two methods to purify mixed companies shares; the first method purify the whole profit whether it is in the form of cash, bonus shares or profit achieved as a result of selling; the second way is to purify share annually.
The first method: The profit gained from share is purified in case of cash distribution by multiplying the value of profit distributed in cash by the purification percentage of profits. In case of bonus shares distribution, the value of the bounce shares shall be calculated and multiplied by the purification percentage of profits to get the amount to be disposed of. In case of purification due to selling of shares, investor shall determine the value of the achieved profits which is the difference between the sale value and purchase value; then the profit values are multiplied by the purification percentage to get the amount to be disposed of.
The second method: Purify the share annually from being doubtfully illegitimate (haram). Shares are calculated by multiplying the number of company shares, subject of purification, by the purification value of the share to get the amount to be disposed of.
Responsibility and Means of Illegitimate Money Disposal
Whereas, the illegitimate (haram) part of money may not be utilized in any way, i.e; to be deducted from Zakat or taxes owed to the State, it shall be disposed of and granting it in righteousness and goodness of the most benefiting work and most people need. If the financial institutions traded the shares for its interest, such institutions shall be responsible for disposing of the illegitimate (haram) income. In case of brokerage firms, brokers shall notify the investors and clients with purification value of profits achieved from cash distribution, bounce shares or shares selling, in addition to, purification value for a share. Some brokerage firms send investments account statement includes the purification amount for convenience of clients without any extra fees for the purpose of providing superior services of Shariah Compliant Stocks.
Dubai steadily seeks to emphasize its position globally towards achieving the initiative “Dubai The Capital of Islamic Economy” launched by His Highness Sheikh Mohammed bin Rashid Al Maktoum, Vice President, Prime Minister and ruler of Dubai, at beginning of 2013, which leaded to a lot of achievements in the past period including the establishment of legitimate authority stipulating the standards of banking and financial systems in compliance with provisions of Shariah and supervising legitimate committees of banks and financial institutions in UAE. Dubai plays a pioneering role in leading global Islamic economy which enables the overcome of all obstacles and challenges facing investors in several financial markets either regionally or globally with regard to having a standardized reference for the legitimacy of “mixed companies” shares by issuing periodic bulletins specializing in companies quarterly assessment to measure their conformity with Shariah for all Shariah Compliant Stocks worlwide.