Stock Purification: 5 Ways How to Purify Your Stock Investment

Purification is one of the important concepts in Islam, and when it comes to stock investment, Muslim investors need to understand this concept. It entails donating earnings from any unintended and unacceptable business activities by companies in which investors have an investment in them.  

Purification in stock markets is removing non-Shariah compliant income, and it complements the screening and investing processes. Investing in the stocks of mixed activity companies is permissible, but it doesn’t make the impermissible income permissible. Therefore, all Muslim scholars agree that every Muslim shareholder should purify this impermissible income by giving it away for charity and not benefitting from it in any way.

Cleansing of Stock Investments

The definition of cleansing stock investment is a process of identifying, separating, and directing the stock’s non-Shariah compliant income to charity.

The cleansing methodology focus on cleansing the impermissible income of the stock. In the context of stock investment, there are 3 scenarios that need income cleansing. We will discuss them in the following:

1- Cleansing non-halal income while holding the halal stocks

In this first scenario, investors hold a halal stock with an impermissible income of less than 5%. Remember, 5% is the maximum threshold for the non-halal income for the Shariah-compliant stock criteria. Although the stock has a halal status, the investor is still obliged to do purification if it has an impermissible income of less than 5%.

In this case, investors may earn cash income from distributed dividends; they may also earn non-cash income such as bonus shares, warrants, or options to subscribe to preference shares. Therefore, there are two ways to cleanse the income in this scenario:

a. Cleansing cash income from dividends

The cleansing is made in proportion to the percentage of the non-Shariah-compliant income of the company. For example, according to the company’s audited financial report, the shariah non-compliant income is 2% of the total income; therefore, investors should distribute 2% of the company’s dividend to charity.

This method sounds simple, but it is difficult for investors to know the non-Shariah-compliant income percentage of the particular company. Almost all index providers or Shariah stock screening institutions only provide the halal status of the stocks without disclosing the percentage of the company’s impermissible income. On the contrary, Musaffa Halal stock screener platform provides the exact percentage of a company’s halal and non-halal income. Thus, investors can use it to purify their cash income effortlessly without checking and analyzing the company’s financial report.

b. Cleansing non-cash benefits

The benefits could be in the form of bonuses, shares, warrants, options, and others. There is no cleansing for such benefits. The reason is that investors do not receive direct cash from those benefits. Investors will receive the cash income in the next cycle of dividend distribution. Therefore, the cleansing will be performed then. Nevertheless, if the investors opt to cash out their benefits or sell the warrants and options, they need to clean the income using the same method as cleansing the cash income.

2- Cleansing capital gain earned from selling the Halal stocks

When investors sell their halal stock at a higher price, they do not need to cleanse their cash income. This is based on the argument that the change in the stock price does not directly reflect the company’s impermissible income or interest-based activity. In fact, market fluctuations in stock prices are a complex phenomenon that relies on various factors, including supply and demand. As a result, the capital gain is not a direct source of non-shariah-compliant income and activities.

3- Cleansing the income earned from stock that has changed its status from halal to not halal

Muslim investors should not hold any stocks that have changed their status from halal to not halal. To put it another way, investors should get rid of it by selling it. This requirement aims to prevent Muslim investors from contributing to non-shariah-compliant businesses. There are two conditions that investors might face in this scenario;

a. The stock price is higher than the initial price

When the halal stock turns into not halal, and the price is higher than the initial price (principal/investor’s capital), investors should dispose them. According to Shariah Advisory Council- Securities Commission Malaysia, if investors sell the stock immediately on the announcement date, they can keep the capital gain, but if they sell it after the announcement date, they can keep the principal and channel the profit to the charity.

For example, an investor purchased a halal stock on 1 May 2019 at $1.00 per share. On 1 May 2021, the stock price went up to $5.00 per share. The stock was declared as non-shariah-compliant stock (not halal) on the same date. If the investor sells it immediately, he can keep capital gain by selling the $5.00 worth of stock. Let’s assume the next day, on 2 May 2021, the stock price increased to $5.50 per share, and the investor decided to sell the stock on this day. Under this scenario, the principal is equal to the price on the announcement date. This is because the price is considered the price of the stock when it has halal status, and any increase in the value is considered Shariah-compliant. Therefore, the investor is entitled to keep $5.00 (as the principal) and channel the $0.50 to the charity.

b. The stock price is lower than the initial price

In another scenario, let’s assume that on the announcement date (1 May 2021), the stock price fell below the acquisition price at $0.85 per share. The investor’s acquisition price is $1.00 per share (principal). If he sells his stock on the same announcement date, he will lose $0.15 per share of his principal. Therefore, the investor can hold the stock and wait until either the stock price goes back to the principal amount or the company pays dividends which can compensate for the loss by the investor due to cleansing. Once the total amount of received dividend and the stock value is equal to the investor’s principal, then he should sell the stock.

Stock investment purification is not merely cleansing the income; Muslim investors also have to pay zakat for it. You can read more about zakat on stock investment here.

Paying zakat and other non-obligatory donations (sadaqah) as a form of stock purification reflects Muslims’ heart and soul purification. As an investor who pays the zakat and donation, this way is the solution to human greed and the desire to accumulate more wealth. It also means establishing a spirit of sacrifice for the sake of Allah.  

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