Shariah Compliant Stocks and

Valuation

BWFS 3013
ISLAMIC
INVESTMENT

A202
2021
TOPIC OUTLINE
◻ Islamic Capital Market
◻ Mudharabah, Syirkah, and Qiradh
◻ Types of Securities
◻ Common Stock
◻ Preferred Stock
◻ Shareholders Reward
◻ Stock Valuation
◻ Shariah Compliant Screening Process
◻ Screening Methodology in Malaysia
◻ Fiqh Justification on Screening Process
Method
INTRODUCTION
• Bank Islam Malaysia Berhad as the first Islamic bank in Malaysia had taken
the initiative to review and identify companies listed on the Kuala Lumpur
Stock Exchange (KLSE) or nowadays known as Bursa Malaysia that is
considered permissible for Muslim to invest in

• June 1997: The Securities Commission Shariah Advisory Council (SAC) has
introduced the Shariah Approved Securities list

• The Shariah approved securities list contains a list of stocks that are listed on
the Kuala Lumpur Stock Exchange of which Muslims can invest in

• In order to accommodate the possibility to participate in the stock market,

various Islamic stock-broking services began to emerge with the first being
BIMB Securities Sdn Bhd, which was established in 1994.
THE FRAMEWORK
Since the fluctuations in
Securities are securities prices can be very
financial assets volatile it is very attractive
investment

People with Issuers of securities Governments

surplus
funds
Traded in the
capital markets

To buy and Use their securities Issue securities to

sell them to raise funds raise funds

Hoping to get
dividends and/or For future
For development
capital gains within expansion of their
projects.
a short time business
COMPONENTS OF ISLAMIC
FINANCIAL SYSTEM
Islamic Financial System

Capital Money Other

Banking Takaful
Market Market Market

Micro
Sukuk Derivatives
Financing

Development Venture
Equity Institutions Capital
ISLAMIC EQUITIES
• Equity-based contracts involve partnership and the sharing of risks and
rewards in a venture in the form of mudharabah or musharakah form of
contract
• Mudharabah:
• Derived from the word dharaba which means traveling for trade
• Mudharabah mutlaqah: Any business is allowed which deemed profitable and
Shariah compliant.
• Mudharabah muqayyadah: Limit the types of business as agreed between two
contracting parties
ISLAMIC EQUITIES

• A type of contract where one of the parties provides capital and the other
presents expertise, labour, and entrepreneurial skill to conduct a particular
business where both parties would share profit
• There are people who have capital but do not know how to use it or where to
invest it. There are others who have the entrepreneurial skills and business
acumen but have no capital
• Mudharabah enables both parties to make profit. Both parties share the profit
but losses are limited to capital provider only, if no negligence occurred
ISLAMIC EQUITIES

• Profits derived from capital gains by purchasing shares or securities sold

at higher prices
• Profits can also be obtained through dividends
• Conditions of mudharabah contract:
❖ Both contracting parties
❖ Capital:
✔ Total amount is known
✔ Payment of capital in cash and is not accrual
✔ Must be delivered to entrepreneur based on wadiah yad
dhamanah

❖ Profit is clearly determined in ratio or percentage

ISLAMIC EQUITIES
Musyarakah:
• A contract of partnership between two parties or more to finance a particular
business joint venture whereby all parties contribute the capital either in the
form of cash or others
• Any profit incurred from the partnership will be shared amongst them based
on an agreed ratio, whereas any loss incurred will be borne by them
according to their ratio of respective capital contribution
• Each partner may or may not participate the business
• A working partner gets a greater profit than sleeping partner
• Often used in investment project, letters of credit, and the purchase of real
estate
ISLAMIC EQUITIES

Musyarakah mutanaqisah:
• Diminishing partnership
• A type of partnership where one of the partners promises to buy the share of
the other gradually until the ownership is fully transferred to him
• Two contracts involved: Partnership and buy selling transaction
• Binding contract: Contract where the parties are not permitted to withdraw
except agreed
• Non-binding contract: Allows parties to terminate the contract unilaterally
even without the agreement (musyarakah falls under this contract)
• Becomes binding if other binding elements exist such as ijarah
ISLAMIC EQUITIES

• Qiradh:
• Generally is hiring someone with for profit – refers to the same concept of
mudharabah
• The definition works like mudharabah
• The only difference is that qiradh is not binding, where each of the
contracting parties is permitted to unilaterally terminate the contract
• Qiradh can be terminated before the commencing of operation n business
 ISLAMIC CAPITAL MARKET

• Going by the shariah, equity financing would be the preferred

financing/investing technique because:
• Equity financing has no fixity of return
• Returns that are tied to the earnings of the underlying business
• A risk-profile not detached from that of the business

• Thus, equity financing is very much profit and loss sharing with all the
business risks thrown in
• Investment in a stock resembles the provision of mudharabah
financing contract
ISLAMIC CAPITAL MARKET
However, not all stocks listed in an exchange may be acceptable from a
Shariah viewpoint.

The need for a shariah evaluation of stocks and the identification of shariah
compliant stock has led to the development of :

• Shariah filters
• Shariah indices
• Shariah compliant REIT (Real Estate Investments Trust) and ETFs
(Exchange Traded Funds)
• Entire industry of Islamic Mutual Funds

All these have meant that there is an Islamic equity market operating in parallel
with the conventional equity market.
SUPPLY, DEMAND, AND PRICE OF
EQUITIES
• The price of a stock fluctuates fundamentally, according to the theory of
supply and demand

• Say, supply equals to the number of shares offered for sale and demand
equals to the number of shares investors wish to buy at exactly the same time

• When buyers outnumber sellers, the price rises

• When sellers outnumber buyers, the price falls

IT’S ALL ABOUT MARKET EQUILIBRIUM

WHAT INFLUENCES DEMAND AND
SUPPLY OF ISLAMIC EQUITIES?
3 groups of investors for Islamic investment:

1. Who would only put their money in investments that comply with Islamic
law.
2. Shariah-compliant preferred investors who would invest in both
conventional and Islamic products but would always have preference for
Shariah-compliant products
3. Returns-sensitive group of investors who would only take up Islamic
investment if their returns are better than other investments
COMPONENTS OF ISLAMIC
CAPITAL MARKET
Stock/ shares

Others like Islamic Islamic Mutual

Private Equity Funds
Funds, Islamic
Structured
Products etc.

Islamic REITs Islamic ETFs

(Real Estate (Exchange
Investment Trade Funds)
Trusts)
DIRECT AND INDIRECT
ISLAMIC EQUITIES
TYPES OF SECURITIES

The third type

There are 2 main types of which is
increasingly
securities namely: becoming
popular is:

The hybrids.
Hybrids are those
Equity Debt that have the
characteristics of
instruments instruments both equity and
debt.
TYPES OF SECURITIES

The most common The most common

equity instrument is the debt instrument is the
common stock bond/sukuk

Generally bonds would

As long as the provide holders a fixed
stockholder has the annual or semi-annual
shares he has a interest payments
residual claim on the (coupon payments) and
firm. full repayment of
principal at maturity.
PROS AND CONS OF STOCK
OWNERSHIP
Pros:
1. Possibility for substantial returns
2. Effective protection against inflation rate by increasing purchasing power
3. Easy to buy and sell
4. Costs associated are modest
5. Information of stocks is widely disseminated
6. Unit cost per share is fairly low

Cons:
7. Substantial various types of risks are built in
8. Returns are highly volatile and hard to predict and identify top performers
9. Selection process of stock is complex
10. Pick the strong future financial performance and golden opportunity before
others bid
11. Distribute less current income with greater uncertainty
HOW SHARES ARE CREATED?
1. Issuing new shares through IPO
2. Stock spin-off (The most creative way)
#Occurs when company gets rid of its subsidiary by creating a new stand
alone company and distribute new shares to existing shareholders
#Shares have been unfit or too diversified – works well for investors
3. Stock splits – increase the number of shares by exchanging a specified
number of new shares for each outstanding shares
#Two-for-one split @ three-for-one split
#Enhance stock’s trading appeal by lowering market price
#Price normally falls in proportion of the split unless accompanied by big
increase in dividend addition
4. Treasury stock – reduce the number of shares by buying back their own
stock
#Issued and repurchased back to be kept by company at a later date for
several purposes
#Repurchase when they viewed as undervalue
#Avoid to pay dividend
#Different tax consequences on shareholders
HOW SHARES ARE CREATED?

#Short term impact of so called buybacks is stock price generally goes

up when company announces their intention
#Long term effect is followed by periods of above average stock returns
5. Classified common stock
#Entitles holders to different privileges and benefits
#Voting and dividend rights
COMMON STOCK
Common stock is Equity instruments that represent ownership
in the company
• A public listed company is jointly owned by its shareholders
• Since the corporation is a separate legal entity, the shareholder is responsible for
any loss up to his total investment

• Right to residual value of the firm

Characteristics • Right to the portions of dividends if
of announced
Common • Right to vote in the AGM/elect and dismiss directors
stock
• Cash: Treated as investment income and
taxable
Common Stock • Stock: Dividend in the form of additional
Dividend stock issued in proportion of stock owned
• Property: Dividend in the form of product and
services
TYPES OF COMMON STOCK
Types of common stock associated with the
underlying company (dividend, size,
growth etc.)
Blue chip Growth Emerging growth Income
•Strong, stable and Strong potential for rapid Industry Mature company with
mature, with a long increased in earnings and high dividend yield and
history of consecutive profits; few prospects for
quarterly dividends; Young firm in new
Earnings growth 15 to 18% industry with good growth or
•Long track record of annually; growth prospects, but diversification;
earning profit and paying also high risk. Those who seek safe
dividend; High operating margins
and high level of
and plentiful cash flow;
•Large, well established, current income;
and leader in industries The company has a strong
potential for outperforming These are typically
•May also be a suitable the market; utility companies,
investment for an investor however, they may also
Pay little or no dividend
with income objective. mostly reinvest the profit. be blue chip companies.
TYPES OF COMMON
STOCK
Types of common stock associated with the
characteristics of the industry

Cyclical stocks Counter-cyclical or defensive stocks Speculative or special situation

stocks
Earnings are closely linked to the
Stocks whose prices remain stable
overall economy; Those for whatever reason, an
even in economic recession;
investor believes will rise quickly in
Less susceptible to downswings in the market price;
Move up and down with business business cycle;
cycle;
Do better in bear markets when
Lack sustained record but still offer
investors are looking for safe places
Move with the broader market and potential for capital growth;
that are not affected greatly by
often with greater volatility. So, economic currents to park their
they outpace the market during an money. Earnings are uncertain and unstable;
expansion but whipsaw back during a
Companies in the food, health care,
contraction.
and defence industries are all Subject to wide swings in price and
Automotive stocks are one example. examples. pay little or no dividend.
MARKET CAPITAL STOCKS

Stocks can also be broken into 3 following

segments on size basis:

Small-Cap Mid-Cap Large-Cap

Less than $2billion;

Offer attractive return opportunities More than $10 billion;
Annual revenues less than $250 without much volatility with safety
million; big established stocks; Few in numbers but covers more
than 75% market value.
Spurts of growth can have a dramatic Contains baby blue chip or baby
effect on earnings and stock prices; blues. Similar characteristics with
blue chip except size;

Tendency to be here today and gone

tomorrow; Solid balance sheet, modest level of
debt, steady profit growth, and pay
modest rate of dividend.
Shares are not widely traded.
COMMON STOCK INVESTMENT
STRATEGIES
Quality long-
Buy and Hold Current term growth Aggressive Speculation
Income Less stock and short
Conservative management term trading
conservative
Secure capital
Aggressive
Aggresively
andTotal
riskier trade in and
Return Known as
Conservative out stock, day Trading,
approach Safety and Approach timing is the capital gain
and value- stability i.e. key element. in short
oriented of income emphasize More trading time period
in a shorter
capital gain period
and high
income
Goal: Goal: Capital
Goal: Goal: Capital Goal: Capital gain
Current
income and Supplemen gain gain
Information
capital t other Tech, baby Demands
gain incomes is less
blues, and time and important
10 to 15 mid-caps high skills
years
ADVANTAGES OF INVESTING
IN COMMON STOCK
Advantages of investing
in Common stock
• Potential of substantial
returns
• Higher rate of return
• Low unit cost
• Less risky due to its position
during liquidation
Disadvantages of
investing in Common
stock
• High in risk and volatility in
return
• Equities selection is complex
based on fundamental
• Distribute less income with
greater uncertainty
PREFERRED STOCK
•A share that does not give a right to the
shareholders to vote at its general meeting
Preferred or any right to participate in any distribution
of the company that has stated the amount,
Stock whether through dividends, redemption,
dissolution or otherwise.

Characteristics of Preferred
stock
Limited voting Call provision right Conversion
feature
in the event of merger,
liquidation or issuance of stock repurchase by to common stock
bond except in the case company
of no dividend paid

68
PREFERRED STOCK

Characteristics of preferred stock

Right to In case of
dividend dissolution

Normally fixed made Given preference

before common stocks with regard to
asset distribution

68
TYPES OF PREFERRED STOCK

Cumulative • Continuous claim to dividend

• Dividend paid before common stockholders
Preferred

• Does not confer steady claim to

Non-cumulative dividend
Preferred • Would not be paid any missed dividend

Participatin • Receive extra dividend over nominal ones

g Preferred

Convertible • Option to convert to common stock

Preferred
ADVANTAGES OF INVESTING IN
PREFERRED STOCK

Advantages of Disadvantages of
investing in investing in
Preferred Preferred stock
stock • Volatility of price
• Can be bought or sold • Convertible to common
easily stock at anytime
• Denied right to voting in
• Legal liabilities are
general meeting
restricted
• Right to receive dividend
prior to common stock
UNDERLYING SHARIAH CONTRACT
OF STOCKS
Musharakah is contract
which involves two or
more parties in a
project or business
Issuance of shares by companies is based on where each of the
principles that relate to contract of parties contributes to
Musharakah the capital and actively
involves in the
management of the
project or business

Thus, the investor who hold the shares of a company actually participate in determining the up and down of
the company

They will share company’s fortune in the form of higher dividend and higher value of the share, and if the
company suffers losses, the shareholder may not receive dividend and experience in declinations of
share values

11
SHARIAH RULINGS ON COMMON
STOCK
In general OIC Fiqh Academy

• It is permissible if the • It is permissible to purchase,

hold, or sell its shares even if
main business of the the company was to undertake
company is in prohibited activities such as
compliance with borrowing money and/or invest
Shariah rulings its money on the basis of
interest, the company can still
be invested provided they
fulfil certain criteria

11
SHARIAH RULINGS ON PREFERRED
STOCK
SAC of Malaysian
OIC Fiqh Academy Securities Convertible
Commission Preferred Stock
• Not permissible • Only Non- • No formal fatwa
cumulative given although
preference shares most Shariah
are permissible scholars are
• Based on tanazul concerned about
element of gharar
concept
• Where the right to
profit of the
common
stockholder is
given willingly to
a preferred
stockholders

70
SHAREHOLDER REWARDS
Cash Bonus issue Shareholder
Rights
dividends or stock benefits or
dividend perks
issues
Current
shareholders Rewards given to
given special shareholders in
Shares in lieu of right to kind rather
No objections cash purchase new than cash,
from
shares below e.g. free food
Shariah
market price or food coupon,
perspectives
hotel stays
etc.
Acceptable to
No objections Shariah Acceptable to
from Shariah
Shariah
COMMON STOCK VALUES
1. Par value
+ An arbitrary amount assigned to a stock when it is first issued
Minimum value of the stock for transaction – setting a floor for stock value
2. Book value
+ Stockholders equity in the company as reported on the
balance sheet – backward-looking estimation value focusing the past
3. Market value
+ The prevailing market price reflects what investors are willing to pay in
order to acquire the company today
+ Market price usually exceeds the book value
+ Can assess total market capitalization by multiplying with total shares
outstanding – forward-looking estimation value
+ If market price falls below book value, company may have been dealing
with financial distress and lack of growth prospect
4. Investment value
+ The most important measure for stockholders
+ Indicates worth investors place on stock they think should be trading for
+ Determination is complex based on expected return and risk
READING THE QUOTES
1. To be an informed investor, basic awareness you need to have is reading
the stock price quotes effectively
2. Keeping track of current prices is an essential element
3. Also, the transaction cost that could consume most of your profits

4. Stock quote for Abercrombie & Fitch on May 15, 2015.

Source: Yahoo! Finance
http://finance.yahoo.com/q?uhb=uh3_finance_vert&fr=&type=2button&s=anf.

5. Major costs are brokerage fees, 1 to 2%, depend on broker services used
and bid-ask spread that represents the degree of liquidity of a stock
INVESTING IN FOREIGN STOCKS
1. The trend of globalization since 1990’s has brought investment borderless
and limitless
2. US stock market accounts 40% of all the rest of the world’s stock markets
combined in 2015 ($27 trillion)
3. In terms of returns, Finland wins over US indicating attractive returns
awaiting investors who are willing to venture beyond borders
4. The restrictions: Market risk, brokerage houses, logistical problem,
currency fluctuation, different regulatory, insider trading, language
barriers, tax issues, etc.
5. Going direct might be troublesome but would be easier through American
Depositary Receipts (ADR)
6. Valuation and the approach to derive information are similar but market
reacts to its own set of economic forces
7. Challenge is to be in the right market at the right time
8. Global investing invites third variable of currency exchange rates that
could affect returns
9. Best thing to join is when home currency is weakening
MEASURING RETURNS OF FOREIGN
STOCKS
Return for expecting the change of wealth in a
specific period in a specific country subject to
exchange rate fluctuation
End FOREX at
value + end
Dividends holding
period

FOREX at
1 HPY
(*100)
Beginning
value beginning
holding
period
STOCK VALUATION
1. Valuation is a process which investor determines the worth of a share for
further investment decision making between the trade-off risk and return
2. The value of asset earning is the present value of expected future cash
flows received from the asset
3. Thus, factors determine the value:
❖ Discount rate
❖ Future stream cash flows
4. Rules of thumb:

Estimated Intrinsic Value > Market Price = Buy

Estimated Intrinsic Value < Market Price = Do not buy, sell
Estimated Intrinsic Value = Market Price = Hold
DIVIDEND VALUATION MODEL
(DVM)
1. Intrinsic value equals to the present value of its expected cash
2. Refers to amount of cash dividends received each year plus future sale
price of the stock
3. Assumption: Dividend received infinitely over time
4. Current value and future price of a stock is a function of future dividends
5. Three types: Zero growth, constant growth, and variable growth models

6. Zero growth = Annual dividends D

Required rate of return R

7. Constant growth = Next year’s dividends D(1+G) D1

Required rate of return – Dividend growth rate R - G

8. Variable growth = Next year’s dividends1, 2 …

(Required rate of return – Dividend growth rate)1 + 2 ...

9. Growth rate = ROE X Retention rate, where RR = 1 – DPR (Dividend

payout ratio)
DIVIDEND VALUATION MODEL
(DVM)

Suppose dividends on a stock today are $1.20 per share and dividends are
expected to increase each year at a rate of 2% per year, forever. If the required
rate of return is 10%, what is the value of a share of stock?
DIVIDEND VALUATION MODEL
(DVM)

If the current price of the stock is $17.43, what would be the

valuation interpretation?

What would be your investment decision?

What would be the price if market is efficient?

DISCOUNTED CASH FLOW
VALUATION MODEL (DCFVM)

Constant rate = Free cash flow

(1 + r)

You invested in Al-Ikhsan with expected cash flow of $0.30 in the first year, $0.50
in the second year and $0.60 in the third year. You required 15% return. If the
market price is $1.50, would you consider to invest?
RELATIVE VALUATION APPROACH
1. Current ratio > 1
2. Dividend yield > 5%
3. PE ratio - mixed - Lower could be undervalued
4. PBV ratio lesser than 1
5. PS ratio at 2 or even less than 1, but high profit
margin comes with high
PS ratio
6. PEG ratio - Lower is better
7. EV per EBIT
8. EV per EBITDA
9. EV per cash flow
RELATIVE VALUATION APPROACH
stock Price Sq ft PER

A $ 110,000 1,700 $ 64.71

B $ 120,000 1,725 $ 69.57

C $ 96,000 1,500 $ 64.00

D $ 99,000 1,550 $ 63.87

E $ 105,000 1,605 $ 65.42

What is the price of a 1,650 sq ft house? Average 65.51

Answer: 1650 × 13.50 = 108,... 11 * 13.50= Price (intrinsic value) compare dgn current price
MAKING INVESTMENT DECISION
1. Buy the shares when the current price undervalues the intrinsic valuation
stock – then only investors would enjoy the excessive required return with
capital gain
2. Buy the shares when the current price overvalues the intrinsic valuation
stock – then only investors would enjoy the discount rate
3. Ranking undervalued stocks – on the basis of excess return ratio. The
larger the ratio, the larger the underpricing, and the larger the excess
return
4. Indicates also margin of safety with at least 20%
5. Continue monitor the price and update the knowledge of the company
6. If variables change, re-estimate the company intrinsic value and the
possibility to sell
7. Sell when the price is fairly occupied at intrinsic value = market price
8. Hold as long as the stock is undervalued
SHARIAH SCREENING PROCESS
• A process of identifying Shariah compliant investment by opting out all
non-aligned assets with Islamic law

• Shariah quantification requirements include sector screening, financial

screening, procedural screening

• The process might differ from one board to another, from one company to
another, and from one country to another, resulting in different share
universe

• Currently there is no international Shariah standard for stock screening

• In Malaysia, we have the list issued by Securities Commission, Dow

Jones-RHB Islamic Malaysia Index, and FBM Shariah Index

• At the international level, we have automated screening providers such as

the Dow Jones Islamic Market Index, FTSE Global Islamic Index Series,
and S&P Islamic Index Series
MALAYSIA SHARIAH SCREENING
PROCESS
• Security Commission is responsible for determining the Shariah
compliant stocks and the Shariah index through its very own Shariah
Advisory Council (SAC)

• In classifying these equities, SAC received input and support from the SC

• The SC obtained information on the companies through, among others,

annual reports and enquiries made to the companies

• SAC, through the SC, will continue to review the Shariah status of
securities listed on Bursa Malaysia, on an annual basis, based on the
latest available annual audited financial statements of the companies
MALAYSIA SHARIAH SCREENING
PROCESS
• Securities Commission of Malaysia applied additional criteria to companies
which involved in mixed business
❖ i.e. companies whose business activities comprise both Shariah
permissible and non-permissible elements
• The analysis is done at the holding company, subsidiary, and associate
company levels. The additional criteria include:
• Core activities of the company are activities not against the
Shariah principles as mentioned earlier
• Haram element is small compared to core activities, i.e.
compared against benchmark
• Public image/perception of company is good
• Core activities of the company are important and of public
interest (maslahah) to the Muslim ummah and the country
• Proportion of haram element is small and in matters such as umum
balwa (common plight), ‘uruf (customs), and the rights of the non-
Muslim community which are accepted by Islam
MALAYSIA SHARIAH SCREENING
PROCESS
• While the above criteria are all subjective, in order to translate these
subjective criterias into actionable filters, SAC adopts a two-tier
quantitative approach
• The objective is to compute the percentage contribution of non-
permissible activities to the company’s total asset. These include:
1. Business Activity Benchmark:
• Evaluation in terms of company activities, products, and industry
2. Financial Ratio Benchmark:
• Computation of a set of specified benchmarks of financial ratios
and compare them against specified benchmarks
BUSINESS ACTIVITY BENCHMARK
• The business activity benchmark is essentially used on a case-by-case
method

• This is applicable for situations where the core activity of the company
has importance and maslahah (benefit in general) to the ummah but
includes a small element that may be classified haram

• The non-permissible activity could also be driven by custom or

involves the rights of non-Muslims

• In analyzing such companies on a case-by-case basis, the SAC

allows for threshold levels anywhere between 5 and 20%.
SECTOR SCREENING
General prescriptions to exclude companies that operate businesses
against the Shariah rulings that exceeds a specific threshold. Applicable for
following business-mixed activities:

• Conventional or interest-based finance (riba)

• Gambling, gaming, casino operations and number forecasting (maysir)
• Prohibited goods and services such as pork, non-halal meat, alcohol,
and prostitution
• Conventional insurance (gharar)
• Tobacco manufacturing or sale
• Stockbroking or trading in non-Shariah securities
• Additional:
• Entertainment deemed non-permissible (include adult entertainment,
cinemas, the music industry, and hotels)
• Weapons and defense
FINANCIAL RATIO BENCHMARK
• Next, a set of measures called financial filters are also used to refine the
selection by analyzing how deeply a firm involved in the contravened
Shariah practice especially riba case to a specific tolerable rate
• The filters use a number of financial ratios and compare them against
their respective benchmarks to weed out non-Shariah compliant stocks
• In general these ratios can be categorized as:
❖ Cash over Total Assets
o Cash will include cash placed in conventional accounts and
instrument
❖ Debt over Total Assets
o Debt will only include interest bearing debt
• The financial ratio benchmark must be lower than 33% threshold
• Both ratios are intended to measure riba and riba based element within a
company balance sheet
SHARIAH SCREENING FRAMEWORK
BUSINESS ACTIVITY BENCHMARK
Previous method prior to November 2013
5% BENCHMARK
• Conventional Banking
• Conventional Insurance
• Gambling
• Liquor and liquor related activities
• Pork and pork related activities
• Non halal food activities
• Shariah non compliant entertainment
10% BENCHMARK
• Interest Income from conventional accounts
and instrument
• Tobacco and tobacco related
20% BENCHMARK
• Rental received from shariah non
compliant activities
25% BENCHMARK
• Hotel & Resorts operations
• Share Trading
• Stockbroking Business
Revised (Current) method effective November 2013
5% BENCHMARK
• Conventional Banking
• Conventional Insurance
• Gambling
• Liquor and liquor related activities
• Pork and pork related activities
• Non halal food activities
• Shariah non compliant entertainment
• Interest Income from conventional accounts and
instrument
• Tobacco and tobacco related
• Other activities deemed non-compliant with
Shariah
20% BENCHMARK
• Rental received from shariah non
compliant activities
• Hotel & Resorts operations
• Share Trading
• Stockbroking Business
EFFECT OF REVISED
METHODOLOGY IN SCREENING
Companies with mixed activities which are currently assessed under the 10%
or 25% benchmarks may be affected because their activities are now
assessed under the 5% or 20% benchmarks

Example:
New Revised
Shariah non- Previous
Company A methodology
compliant activity methodology [10%
[5% benchmark]
benchmark]
• Cigarettes (tobacco) • Tobacco’s revenue / • Status : • Status:
• Listed on Main Market, Group revenue Shariah-compliant Shariah non-compliant
Bursa Malaysia = 9%
• Business activities:
Property
development,
trading of building,
materials and manufacture,
and distribution
EFFECT OF REVISED
METHODOLOGY IN SCREENING
Companies with high level of conventional debt may also be affected as
previously, there was no screening rules on total conventional debt of the
company

Example:
New Revised
Level of Conventional Previous methodology
Company B methodology
Debt
[33% benchmark]
• Cigarettes (tobacco) • Total conventional debt • Not applicable • Status:
• Listed on Main Market, / Group total asset Shariah non-compliant
Bursa Malaysia = 36%
• Business activities:
Property
development, trading
of building materials
and construction
works
EFFECT OF REVISED
METHODOLOGY IN SCREENING
Companies with high level of conventional debt may also be affected as
previously, there was no screening rules on total conventional debt of the
company

Example:
New Revised
Level of Conventional Previous methodology
Company B methodology
Debt
[33% benchmark]
• Cigarettes (tobacco) • Total conventional debt • Not applicable • Status:
• Listed on Main Market, / Group total asset Shariah non-compliant
Bursa Malaysia = 36%
• Business activities:
Property
development, trading
of building materials
and construction
works
TREATMENT TO THE CHANGE OF
SHARIAH COMPLIANT ASSET
These refer to the securities which were earlier classified as Shariah-
compliant, but, due to certain factors such as changes in the company’s
business operations and financial positions, are subsequently reclassified as
Shariah non-compliant
Example:
Price On Announcement Date Price After Announcement Date

Price > Original Price < Original Price > Original Price < Original
investment cost investment cost investment cost investment cost
• Dispose securities • Permissible to hold • Dispose securities • Permissible to keep the
• Any capital gain securities until the price • Profit (different securities until the
and dividend is equivalents to investment from investment price equates the
permissible to keep cost cost and the closing original
• Dividend can be used price is permissible investment cost
to improve the to keep) • Dividend can be used
disposal process • Profit (different from to improve the
the dispose price and disposal process
closing price is donated
to charity)
ILLUSTRATIONS
• ABC Berhad has a small division which is a conventional finance company.
The revenue and profit before tax contribution of this division do not exceed
5% of the entire company’s total revenue and profit before tax – Shariah
compliant

• DEF Berhad is a conglomerate that has a wholly-owned subsidiary involved in

the hotel business. Revenue and profit before tax from that subsidiary
comprise approximately 20% of the group’s revenue and profit before tax -
Shariah compliant

• GHI Berhad has investment in an associate company that operates a brewery,

which contributes about 8% of the company’s total profit before tax – Shariah
non-compliant

• JKL Berhad has a subsidiary that is a licensed distributor of tobacco products.

While this subsidiary make up about 15% of JKL’s profit before tax – Shariah
non-compliant
AL-MEEZAN INVESTMENT
MANAGEMENT LIMITED PAKISTAN

1. Core business halal and in line with Shariah dictates

2. Debt to total assets should be less than 37% including zero coupon bond
and preference shares
3. Non-compliant investment to total assets should be less than 33%
4. Non-compliant income to total revenue should be less than 5%
5. Illiquid assets to total assets should be at least 20% (asset permissible to
be traded at value other than par)
6. Net liquid assets to share price. Market price per share should be greater
than the net liquid assets per share
SHARIAH SCREENING PROCESS
MALAYSIA VS PAKISTAN
SCREENING PROCESS EFFECT
• Since the SAC criteria in Malaysia is rather specific, using a stringent
filter will result in a smaller group of eligible stocks and therefore a much
narrower investible spectrum for Muslim investors in Malaysia
• One might ask, what is wrong with having a smaller but ‘purer’ group of
investible stocks?
• There are several problems with this:
✔ From a portfolio theory viewpoint, a smaller investible group of
stocks restricts diversification and limits the benefits of
diversification
✔ One cannot form efficient portfolios or superior risk-return portfolios if
the group of investible stocks is restricted
✔ By implication, one cannot be on the ‘optimal’ efficient frontier or
get closed to such a frontier
• As with everything else in economics, there is a trade-off. The cost may
be less efficient to construct the portfolios
FIQH JUSTIFICATION ON SHARIAH
BENCHMARK
Status of mixed business companies:
• No historical precedent. Public image must be good
• Cited Ibnu Subki in Al-Ashbah wa al-Naza’ir, “to rule as prohibited
something that is a mix of the permissible and the prohibited is
ihtiyat (precautionary measure) and it is not necessarily
prohibited”.
SAC of SC took into account other Fiqh principles to support
their case:
• Maslahah (beneficial and public interest)
• ‘Umum balwa (difficult to avoid)
• ‘Urf khas min asalib iqtisodiyah,
• Fasaduz zaman
• Huquq ghair Muslimin
FIQH JUSTIFICATION ON SHARIAH
BENCHMARK
In addition, they also cited Ibnu Qayyim who wrote in his book
“Bada’ie al-Fawa’id” about the nature of prohibited property which is
of 2 kinds:
• Prohibited because of its zat (nature),
e.g. pork, liquor. Hence mixing of meat slaughtered by Muslim
and non Ahli Kitab is prohibited.
• Prohibited due to other reasons such as the means or the way it
is earned or acquired.
e.g. money in itself is fine, but, the manner it is acquired such
as by robbery is not acceptable. Shares of companies are by
nature acceptable but shares of mixed business companies may
not be acceptable.
FIQH JUSTIFICATION ON SHARIAH
BENCHMARK
50% rule
• Utilize the fatwa concerning silk mixed with common thread. This
is based on the hadith of the Prophet S.A.W:
“The Prophet S.A/W took a piece of silk and placed it on his
right. He took some gold and placed it on his left. Then he
said: “Both these things are prohibited unto men among my
followers, but permissible for the women”

• If it is pure silk then it is prohibited for men to wear the silk-

cloth, but, if the cloth is mixed with 50% or less silk and the
remaining is common-thread, then it is unhindered
FIQH JUSTIFICATION ON SHARIAH
BENCHMARK
• One third or 33% rule:

• Utilizes the analogy of hibah (gift) where a person can bequeath

a maximum of one third of his property as gift to an unrelated
person
• Benchmark based on ghubn fahish (extraordinary margin or profit
or gain)
• Describes gain through cheating and manipulation (tanajush)
FIQH JUSTIFICATION ON SHARIAH
BENCHMARK
• Ghubn fahish accompanied by tanajush is not permissible
• Hanafi mazhab ruled that the upper limits for ghubn fahish
are as follows:
• 5% for ordinary goods
• 10% for animals used for riding and
• 20% for fixed assets
Summary Islamic Equities
Market

Types of Stocks and

Equities
In this Shareholder
chapter Reward
you have ___
Stock Valuation
learned
about: Shariah Screening
Process

Screening Methodology
for Shariah Compliant
Assets in Malaysia
Fiqh Justification on
Screening Method
THANK YOU