Shariah compliance of stocks is done under the guidance of qualified and reputed Shariah experts. For stocks to be “Shariah compliant”, it must meet ALL the six key tests given below.
Core business of the company must be halal and in line with the dictates of Shariah. Hence, investment in securities of any company dealing in conventional banking, conventional insurance, alcoholic drinks, tobacco, pork production, arms manufacturing, pornography or related activities is not permissible.
The ratio of non compliant income to total revenue should be less than 5%. Total revenue includes Gross revenue plus any other income earned by the company. This amount is cleansed out as charity as a pro rata ratio of dividends issued by the company.
The ratio of non compliant investments to total assets should be less than 33%. Investment in any non-compliant security shall be included for the calculation of this ratio.
Debt to Asset ratio should be less than 37%. Debt, in this case, is classified as any interest bearing debts. Zero coupon bonds and preference shares are, both, by definition, part of debt.
The ratio of illiquid assets to total assets should be at least 25%. Illiquid asset, here, is defined as any asset that that Shariah permits to be traded at value other than the par.
The market price per share should be greater than the net liquid assets per share calculated as: (Total Assets – Illiquid Assets – Total Liabilities) divided by number of shares