To check whether a stock is Shariah-compliant, you run two tests. First, a business screen: the company must not earn more than 5% of its income from prohibited activities. Second, a financial screen: its interest-bearing debt and cash must stay below about 30% to 33% of its market value or total assets, depending on the methodology. If it passes both, you then purify any small non-compliant income from your dividends.
This guide walks through each step using the published rules of two major index providers, shows where those rules differ, and lists the mistakes that most often lead investors to hold a stock that no longer qualifies. It explains how screening works. It is not a religious ruling or investment advice.
What you need before you start
- The company’s latest annual report, or its income statement and balance sheet from a financial data site.
- Its market capitalisation history. Some methods use a 12, 24 or 36-month average, so a single day’s figure is not enough.
- A chosen methodology. Decide whose rules you will follow before you start, because different methods give different answers for the same stock.
- A spreadsheet or calculator for the ratios.
Step 1: Choose the methodology you will follow
Pick one published standard and apply it consistently. Most retail investors follow an index provider’s rules or the method used by their Shariah-compliant fund or app, since those rules are written down and reviewed by a Shariah board.
The two most widely referenced public methodologies differ in one important way. The S&P Shariah Indices methodology measures debt and cash against the company’s market value averaged over 36 months. The MSCI Islamic Index Series methodology measures them against total assets.
| Test | S&P Shariah Indices | MSCI Islamic Index Series |
|---|---|---|
| Non-permissible income (incl. interest) | Below 5% of total income | Below 5% of total income |
| Interest-bearing debt | Below 30% of market value (36-month average) | Below 33.33% of total assets (30% for new inclusions) |
| Cash and interest-bearing securities | Below 30% of market value (36-month average) | Below 33.33% of total assets (30% for new inclusions) |
| Receivables plus cash | No current test | Below 33.33% of total assets (30% for new inclusions) |
| Who screens | Ratings Intelligence Partners with a Shariah Supervisory Board, monthly | MSCI’s Shariah advisers, certified quarterly |
Because the denominators differ, a company with a high share price and modest assets can pass one test and fail the other. That is why your first decision is which rulebook to use.
Step 2: Screen the company’s core business
Check what the company actually does. Both methodologies exclude companies whose main business is in a prohibited sector. S&P’s list includes alcohol, gambling, pork-related activities, tobacco and vaping, adult entertainment, recreational cannabis and conventional financial services, with an exception for Islamic banks and qualifying Islamic insurers.
Read the segment breakdown in the annual report, not just the company’s description of itself. A hotel group with a large bar and casino segment, or a retailer that earns significant revenue from alcohol, may fail here even though its brand does not suggest it.
Step 3: Calculate the non-permissible income ratio
Add up all income from prohibited activities plus all interest income, then divide by total income. The result must be below 5% under both S&P and MSCI.
Interest income is the item most people miss. A technology company with a large cash pile can earn substantial interest on deposits, and that interest counts toward the 5% limit even though the company sells nothing prohibited.
Step 4: Calculate the debt ratio
Take the company’s total interest-bearing debt and divide it by the denominator your methodology uses. Under S&P, that is the average market value of the company’s shares over the past 36 months, and the result must be below 30%.
Here is a simple illustration with hypothetical numbers. A company has $3 billion of interest-bearing debt and an average market value of $12 billion over three years. Its debt ratio is 25%, so it passes the S&P test. If its total assets were $8 billion, the MSCI ratio would be 37.5%, and it would fail.
Step 5: Calculate the cash and receivables ratios
Add cash, deposits and interest-bearing securities, then divide by the same denominator. Under S&P the limit is 30% of average market value. MSCI applies 33.33% of total assets and adds a third test on receivables plus cash.
The idea behind these tests is that a share should represent mainly real business assets, not a claim on cash and debts. A company whose balance sheet is mostly cash behaves more like a deposit than a business.
Step 6: Purify your dividends
Even a compliant company may earn a small amount of non-permissible income. Purification means giving that share of your dividend to charity. S&P’s formula is: dividend multiplied by (non-permissible revenue divided by total income).
For example, if you receive a $200 dividend and 2% of the company’s income is non-permissible, you would give $4 to charity. MSCI applies a similar adjustment to reinvested dividends and updates the factor every quarter.
Step 7: Re-check the stock regularly
Compliance is not permanent. S&P’s screening partner reviews constituents every month, and MSCI’s Shariah advisers certify its indexes every quarter. If you hold individual stocks, re-run your screen at least after each annual and half-year report, or whenever the company makes a large acquisition or takes on significant new debt.
Common mistakes to avoid
- Using today’s market cap for a 36-month test. A share price spike can make the debt ratio look fine for a few weeks. S&P uses a 36-month average precisely to smooth this out, so use the average.
- Ignoring interest income on cash. Large cash holders can breach the 5% income limit through deposit interest alone.
- Mixing methodologies. Taking S&P’s debt rule and MSCI’s cash rule, or switching method until a stock passes, defeats the point of following a reviewed standard.
- Forgetting the buffer rules. Both providers give existing holdings some room before removing them. MSCI admits new stocks only below 30% but keeps existing ones up to 33.33%. A stock that is “still in the index” may not qualify as a new purchase.
- Treating an app’s label as final. Screening apps and funds use different methods. Check which standard an app follows and whether it shows the underlying ratios.
FAQ
Mainly because they use different denominators and limits. S&P measures debt against average market value, while MSCI measures it against total assets. A company can pass one and fail the other without anything changing in its business.
Usually, yes. A fund or index-tracking ETF screens, re-checks and purifies for you, and names the Shariah board that approves it. You still need to read its methodology and fees.
Index providers remove it at the next review. Individual investors generally sell within a reasonable period and purify any income earned after the stock stopped qualifying. Ask a qualified scholar how this applies to your situation.
Conventional banks fail the business screen. Islamic banks, Islamic financial institutions and qualifying Islamic insurers are an exception under the S&P methodology.
Next step
Once you know how screening works, the next question is how to build a balanced portfolio around it. Read our guide to Shariah-compliant investment principles and options, which covers funds, sukuk, gold and property. This article is for information only and is not investment advice or a fatwa. Consult a licensed adviser and a qualified scholar before making decisions.
