Haram

• The Bottom Line: In an investment context, “Haram” refers to activities and financial practices forbidden by Islamic law, offering a powerful, centuries-old framework for risk-averse, ethical investing that surprisingly mirrors core value investing principles like avoiding excessive debt and pure speculation.
• Key Takeaways:
• What it is: A set of principles that screen out investments involved in specific industries (like alcohol, gambling) and financial practices, most notably the charging or paying of interest (`riba`).
• Why it matters: It provides a non-negotiable filter that systematically steers investors away from highly leveraged, speculative, and often unpredictable businesses, thereby strengthening risk_management and promoting a long-term mindset.
• How to use it: Investors can apply its core tenets by screening companies for low levels of debt, avoiding purely speculative ventures, and ensuring a company's primary business is creating tangible value.

In Arabic, the word “Haram” (حَرَام) simply means “forbidden” or “prohibited.” It's the opposite of “Halal,” which means “permissible.” While these terms apply to all aspects of life in Islam, from diet to conduct, they have profound implications for finance and investing. For an investor, think of the Haram/Halal distinction as a powerful dietary code for your portfolio. Just as someone might avoid trans fats, excessive sugar, and highly processed foods to maintain their physical health, an investor following these principles avoids certain financial “ingredients” to ensure the long-term health and ethical integrity of their investments. This “diet” has a few core rules that are surprisingly relevant to any prudent, long-term investor. The main prohibitions in investing are: 1. Riba (Interest): This is the big one. `Riba` refers to any fixed, predetermined return for the lending of money—what we simply call interest. The philosophy here is that money itself should not be a commodity that you can “rent” out for a guaranteed profit. Instead, capital should be deployed in a partnership where the provider of funds shares in the actual profits and losses of a real enterprise. It demands that money be tied to real economic activity, not just the act of lending. 2. Gharar (Excessive Uncertainty or Ambiguity): This concept forbids contracts or transactions that are overly speculative, uncertain, or where key details are unknown or ambiguous. Think of buying a sealed box without knowing its contents. In modern finance, this serves as a warning against overly complex derivatives or ventures where the business model is opaque and success depends on pure chance rather than a sound operational strategy. It’s a direct challenge to the idea of gambling on outcomes you can't reasonably analyze. 3. Maysir (Gambling): This is a more direct prohibition against games of pure chance. It's the difference between buying a lottery ticket (`maysir`) and buying a share of a local, profitable bakery. One is a zero-sum game of chance where wealth is merely transferred; the other is an investment in an enterprise that creates new wealth through its products and services. 4. Prohibited Industries: The framework also screens out entire business sectors that are considered harmful or unethical. These typically include:

• Alcohol and tobacco
• Pork-related products
• Conventional financial services (banks, insurance companies that deal in interest)
• Gambling and casinos
• Adult entertainment
• Weapons and defense manufacturing

> “The basic ideas of investing are to look at stocks as businesses, use the market's fluctuations to your advantage, and seek a margin of safety. That's what we've been doing. We're going to keep doing it.” - Warren Buffett ¹⁾

At first glance, a set of religious guidelines might seem distant from the world of benjamin_graham and warren_buffett. But when you look closer, the core tenets of Haram investing are not just compatible with value investing; they actively reinforce its most important principles. For a value investor, this ancient framework is a masterclass in discipline and risk aversion. 1. A Natural Aversion to Debt: Value investors are famously wary of leverage. Debt can turn a good business into a fragile one, and a temporary business downturn into a permanent bankruptcy. The prohibition of `riba` (interest) forces investors to favor companies that are not dependent on borrowing. A company that funds its growth through retained earnings and equity is inherently more resilient. It's the corporate equivalent of a family that lives within its means. This built-in screen for low-debt companies is a powerful tool for finding robust businesses and automatically bolsters an investor's margin_of_safety. A business that doesn't owe money to anyone is a business that is master of its own destiny. 2. A Mandated Shield Against Speculation: Benjamin Graham famously distinguished between investment and speculation: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” The prohibitions on `gharar` (uncertainty) and `maysir` (gambling) are, in essence, a codification of Graham's definition. This framework forces you to ask:

• Am I buying a piece of a real, understandable business that creates value? (Investing)
• Or am I betting on a price movement, a complex financial instrument I don't fully grasp, or a “story stock” with no current earnings? (Speculating)

By filtering out speculative ventures, the principles keep an investor grounded in the tangible reality of a business's operations and its intrinsic_value. 3. A Focus on Tangible, Value-Creating Businesses: Because this framework forbids profiting from money itself (interest) and from pure chance (gambling), it naturally channels capital towards companies that make things and do things. It prioritizes investment in the real economy—companies that manufacture goods, provide essential services, innovate in technology, or sell products to consumers. This aligns perfectly with the value investor's mindset of being a part-owner in a productive enterprise, not just a trader of electronic symbols on a screen. 4. A Non-Negotiable Investment Checklist: Successful value investors are disciplined. They operate with a strict set of criteria and are willing to say “no” to 99 out of 100 ideas. The Haram framework provides just such a non-negotiable checklist. Before you even begin to analyze a company's financials or competitive advantages, you run it through this initial screen. Is it in a forbidden industry? Is it drowning in debt? This level of discipline is a powerful defense against “fear of missing out” (FOMO) and emotional decision-making.

While the philosophy is deep, its practical application in modern finance has been standardized into a clear, multi-step screening process. Whether you are using a Shariah-compliant fund or doing your own analysis, the methodology is the same.

An investor would typically apply these screens in order. If a company fails any one of them, it is considered non-investable, or “Haram.”

1. Step 1: Business Activity Screen
   • The first and most straightforward step is to examine what the company actually does. Does its primary business involve any of the prohibited industries?
   • The 5% Rule: In practice, many screening bodies recognize that large conglomerates may have a tiny, non-core part of their business in a prohibited area. A common tolerance threshold is that a company is acceptable if its revenue from Haram sources is less than 5% of its total revenue. For example, a hotel chain that earns 2% of its revenue from an in-house bar might still pass this screen.
2. Step 2: Financial Ratio Screens
   • This is where the principles are translated into hard numbers, and the overlap with conservative value investing becomes crystal clear. These screens are designed to eliminate companies that engage in or benefit excessively from practices related to `riba`. The most common thresholds are:
   • Debt Compliance: Total Debt divided by Total Assets must be less than 33%. This is a very strict leverage test. It ensures the company is not heavily financed by interest-bearing debt.
   • Cash Compliance: (Cash + Interest-Bearing Securities) divided by Total Assets must be less than 33%. This screen is designed to ensure the company is not hoarding cash in interest-bearing bank accounts or securities, effectively acting like a lender itself.
   • Receivables Compliance: Accounts Receivable divided by Total Assets must be less than 33%. This is sometimes combined with the cash screen. It prevents companies from operating in a way that is too similar to a financing business. ²⁾
3. Step 3: Income Purification
   • If a company passes the first two screens but still derives a tiny amount of its income from prohibited sources (e.g., interest earned on its corporate cash account, which is almost unavoidable), an investor is required to “purify” that portion of their earnings.
   • This involves calculating the small percentage of impure income per share and donating that amount to charity. This act acknowledges that even in an otherwise permissible company, one should not personally benefit from forbidden activities.

Let's compare two hypothetical companies through this lens: “Steady Spices Inc.” and “Venture Finance Corp.”

As you can see, the framework doesn't just eliminate Venture Finance Corp. because it's a bank. It also confirms the investment-worthiness of Steady Spices Inc. by highlighting its strong, low-leverage balance sheet—a quality any value investor would admire.

• Inherent Risk Management: The strict limits on debt provide a powerful, automatic defense against financial risk and business fragility. This naturally leads to a portfolio of more resilient companies.
• Promotes Long-Term Thinking: By screening out speculation and focusing on the underlying business, the framework encourages a patient, business-owner mentality, which is the heart of value investing.
• Ethical & Socially Responsible: For investors who want to align their money with their values, it provides a clear and consistent ethical framework that predates the modern esg_investing movement by centuries.
• Discipline and Simplicity: The rules-based approach reduces the temptation to chase hot stocks or make emotional decisions, enforcing a healthy discipline.

• Significantly Limited Universe: This is the most significant drawback. Applying these screens will eliminate the entire conventional financial sector (banks, insurance), most utility companies (which are often highly leveraged), and any other company that uses significant debt. This can lead to a lack of diversification and a smaller pool of potential investments.
• Potential for Sector Bias and Underperformance: By excluding major sectors of the economy, a portfolio based on these principles can underperform the broader market for long periods, especially during bull runs led by financial or highly-leveraged tech companies.
• Rigidity Can Be a Flaw: A fantastic business might be excluded because its debt-to-asset ratio is 34% instead of 33%. This rigidity means you might pass on a wonderful company at a fair price because of a minor screen failure.
• False Sense of Security: Passing the screens does not automatically make a company a good investment. It is still crucial to perform a thorough analysis of its intrinsic_value, competitive advantages (economic_moat), and management quality. The screens are a starting point, not the entire analysis.

• risk_management
• margin_of_safety
• debt_to_equity_ratio
• speculation
• esg_investing
• circle_of_competence
• intrinsic_value