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All You Need to Know About Shariah Stocks and How to Trade in Them

27 July 2019

What is Shariah and what are Shariah Stocks? Shariah is the law of Islam. It is an amalgamation of laws from the Quran (the holy book of Islam religion) and Fatwas, the rulings of Islamic scholars. The Shariah law lays down a code that all religious Muslims are asked to adhere to. The Shariah law also elucidates codes for day-to-day activities like prayers and fasting. There are Shariah scholars who Muslims can turn to if they need help to make decisions in the field of business, finance and family law.

Shariah Screening Process: Shariah screening is a test conducted on all the listed equities to check if the stocks and their parent companies are compliant with all the Shariah laws and fatwas or not. If they are suitable to be traded in – as per Islamic laws- they are included in the Shariah index. This is a quarterly process. Those stocks that successfully pass the Shariah screening are thus called Shariah compliant stocks.

Shariah Investment principles:

Keeping in mind all the teachings of the Islamic religion, especially on what is permitted and what is prohibited, there are certain Shariah Investment principles laid down in the laws. These key investment principles are:

·  Primary business ofthe listed company must be halal- i.e. should be permissible according to the Shariahlaw. This literally means that the companies engaged in gambling, alcohol,weapons, tobacco, pornography or pork are excluded. These activities are Haramin the Islamic law, which means that they are forbidden.

·   A company whichhas total Debt to Market Value of Equity (12 Month average) greater than orequal to 33%, is not consider as a Shariah Compliant company. Thedebt-to-equity (D/E) ratio is calculated by dividing a company’s totalliabilities by its shareholder equity.

·  A company whichhas Market Value of Equity (12 Month average) greater than or equal to 49%, isexcluded from the Shariah indices. Market value of equity is the total currencyvalue of a company's equity. It is calculated by multiplying the current stockprice by total outstanding shares.

·  However, incertain cases, revenues from noncompliant activities are permissible, if theycomply with the following threshold: Non-Permissible Income other than InterestIncome less than 5%. The company must religiously purify these incomes bydonating them to charity since they are considered impure.

·  For stocks to beShariah-compliant, they must appoint a Shariah board, they must conduct anannual Shariah audit.

Why are Shariah Stocks Important?

Shariah stocks are gaining popularity as an ethical investment option for people who see stock market as a form of gambling. With the increasing popularity of socially responsible investing, the popularity of Shariah stocks has boomed as well. There are several companies who maintain Shariah Indices. One prominent company being S&P Dow Jones.  The S&P 500 Shariah was launched in December 2006. This is comprised of all the Shariah-compliant constituents in the S&P 500.

The parallel or future of this stock index could also be the social stock exchange which would contain stocks of the companies which are a social enterprise. This might also lead to a culture of having stock markets which are more thematic and cater to a social need-based segregation or categorization instead of capital-based segregation of companies.

How to trade in Shariah Stocks?

One must have a DEMAT account and a trading account to be able to trade in Shariah stocks in India. Trade in the Shariah stocks is like trade in regular stocks and thus, one must open their account with a brokerage firm. The trading account is the platform where you will execute your trading moves like placing buy orders and sell orders. Similarly, your DEMAT account becomes the placeholder of your shares that you have bought in a dematerialized form. Once these two accounts are setup, one can effectively follow these indices and trade in Shariah stocks.

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