Where to find above-market income on the ASX – plus two standout picks

Traditionally, investors who have wanted yield have needed only to look at what a company has paid in the past and the consistency with which they have paid it in order to construct a fairly high-yielding and robust portfolio.

But with share prices surging and earnings not growing as fast, it's not so simple anymore. Take the poster child for the movement, Commonwealth Bank (ASX: CBA), as an example. When it was first listed, its yield was north of 7%. Today, it hovers around 3%. 

Many would point to the fact that the CBA share price has risen circa 50% in the past 12 months as adequate compensation for the lower yield, but for many investors, there is not even an inkling of selling to crystallise those gains. 

"Been in CBA since 2014. I'm not going anywhere", was the comment from Tom, a Livewire reader, on a recent wire about CBA's valuation. Imagine if you bought in the IPO in 1991 - "they'll have to pry them out of my cold, dead hands" was the comment from another reader. 

Some investors rely on suitable yields to fund their retirements, and a sub 4% average yield on the ASX All Ordinaries doesn't cut it. So, how are the professionals hunting for yield in the current environment? Are they sticking to the tried and tested methods, believing this is just another part of the cycle, or have they changed tack?

To answer those questions, Livewire's Sara Allen is joined by Michael O'Neill from IML and Ben Clark from TMS Private Wealth. For good measure, our guests each bring along their top income stock for the year ahead. 

Note: This episode was recorded on Wednesday, 12 February 2025. You can watch the video, listen to the podcast or read an edited transcript below.

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Edited Transcript

Sara Allen: Hello, and welcome to Livewire's Buy Hold Sell. I'm Sara Allen. Today, the current yield on the ASX 200 hovers below 4%. We're going to unpack how the professionals identify companies with strong income generating potential. To do that, we're joined by Ben Clark from TMS Private Wealth and Michael O'Neill from IML. Thank you both for joining me today.

Yield compression

Michael, I'm going to start with you. Why has the ASX seen yield compression?

Michael O'Neill: Well, if you look at the yield for the ASX index on a market cap weighted basis, the yield decline has really been driven by the large sectors; the financials, the resources, and some of the tech or momentum stocks that tend to pay a lower yield and command a higher valuation. So if you go back three years, materials were paying a yield of something like 8.5%. It's now 3.8%, largely because of commodity demands from China falling and prices correcting. For the financials, major banks make up 25% of our index. They're up 35% in the last year, and dividends haven't kept pace with market caps. So you can see that dilutionary effect at the index level.

But if you go a layer beneath and look at the actual distributions of yield available on the index, the median yields, they haven't moved nearly as much. In fact, some sectors, like some of the industrials or staples or healthcare sectors, have held the yield or in some cases grown it. So plenty of opportunities for active investors to get yield.

Sara Allen: Is there anything you want to add to that, Ben?

Ben Clark: Yeah, they're all good points. I totally agree that if you looked at the ASX 20 or the ASX 50, if you wanted to really simplify it, is that earnings haven't grown as fast as share prices, and dividends are linked to earnings. And so that does tend to happen in earlier stages of bull markets. So it might be that we're going to see earnings upgrades come and it doesn't look as bad as it is at the moment. But where we stand right now, that's the main reason.

If I was calling out one other thing, I'd say that over the last decade in boardroom Australia, directors are much more willing to reinvest back into businesses these days than they used to be. They used to be, I think, more tied to a dividend. And now the fear of disruption and business decline, is much more front and centre. So payout ratios have probably fallen as well, which would be another impact.

Sara Allen: Ben, I'm going to stay with you. The last time the yield on the ASX 200 was above 5% was March 2020. It's around 3.5% now. What's changed?

Ben Clark: Well, again, the biggest thing that's changed is that we were in a full-blown crisis back then. COVID had broken out. We saw the market was under 5,000 points on the All Ords. It's now close to 9,000 points. If I was calling out one thing that also has changed that people don't think about too much, is that during that period, the first thing boards did was that they froze dividends. They said we're not paying out dividends until we know what the outlook looks like.

The second thing that many companies did was they did emergency capital raisings. And what that meant was that coming out of the crisis, because in fact many of those companies didn't actually need to do an emergency capital raising, you've got more shares on issue versus potentially the same profit and dividend payment, which means that the yield is lower. So that's something you always want to think about, is can a company avoid having to do that when you're looking at yield?

Is this the new normal?

Sara Allen: So Michael, would you say this is the new normal? Is this low yield a sign of overstretched valuations?

Michael O'Neill: The market is always changing, but when we do reach stretched levels or extremes, it finds a way of correcting. If you looked at the valuation appreciation in global indices and Australia at near-highs, the market having been driven by a narrow group of sectors and stocks, it does seem unsustainable. And that part of the market, valuations are quite vulnerable. They've expanded a lot, while the bulk of industrial companies really haven't had their valuations expanded at all. So we're seeing very high levels of dispersion.

The other thing we're seeing is an equity risk premium, the premium that you get for investing in stocks over and above lower-risk alternatives, being at or near historic lows in most markets, including Australia. So something seems like it has to give.

Sara Allen: What else are you seeing, Ben?

Ben Clark: I don't think it's a new normal. The market is strong at the moment. We're pretty close to all-time highs. There'll be corrections, crises. There'll be times when you can lock in much better dividend yields again. Who knows when or how far off that is, but don't give up on never being able to earn a good yield out of the market. I'd also say you still want to focus on quality businesses. You can make the mistake of moving down the quality chain to try and lock in a better yield, and that can potentially lead to capital decline and end up being a more expensive error.

Change of strategy?

Sara Allen: Given this current environment, and whether it's a new normal or not, do you think investors need to be changing their income strategy?

Ben Clark: To us, the strategy should be, when you say income strategy… I think income is a nice byproduct of a good business. It shouldn't be the sole reason that you're making a decision to own stock in a business. And to us, it's always been about a total return of which a component is income and a component is hopefully capital growth over a long period of time. I think that mentality is important, because otherwise you can end up in strange parts of the market that, as I said before, you're hunting for yield.

Sticking to total returns is a big thing for me, and avoid the trap of thinking I have to go to a Bendigo Bank versus a Commonwealth Bank, as an extreme example, or South32 as opposed to a BHP, which can lead to potentially bad capital outcomes.

Sara Allen: So would you also say it's a business as usual approach, don't change your strategy?

Michael O'Neill: I'd say for active investors, it certainly is business as usual, because the opportunity set that we face is as rich as it's ever been. But if you've been reliant on the index itself or the concentration in the dividend heroes of the past, the major banks and the resource companies, that strategy would need to change.

Key factors to look for

Sara Allen: So, turning now to the process for finding yield on the ASX, what are the key factors that you're looking at, Michael?

Michael O'Neill: Well, I completely agree with you when you say quality and total return and then income, because that can be a trap. I'd say most of all we look for diversification. So stepping aside from the big sectors that dominate our index where it's not a natural default to be investing such a high proportion in cyclical banks and resources. Seek out industrial companies, which can compound their earnings, grow their dividends over time. But then also diversification of income sources, not just dividends, but ranking, simple option strategies which can hold up your income when dividends are challenged. And I'll echo Ben's point, it's as much about capital.

So there are actually opportunities out there for companies with good dividends but with a stable or potential upside to their valuations which have been left behind. Investing in those companies will hold you in better stead, even if the market's a bit volatile.

Sara Allen: Ben, quality, total return. Anything else that you think investors should be focused?

Ben Clark: When you're looking at an individual business, the first thing you should always be looking at is the balance sheet. You need to be confident that if there's an external or an internal shock, that the company can continue to pay a dividend yield, if that's what you're signing up for. I reckon the poster child for that at the moment is Star Group, which was seen as highly defensive, good income payer, a bit of growth, not much could go wrong. We've seen some things have impacted it, but ultimately it just had too much debt. It couldn't get through that period without doing these emergency capital raisings. So that's one thing.

We've definitely noticed that it feels like yield is starting to be packaged again, which we saw leading into the GFC. So we're seeing issues coming to market which are very heavily reliant on marketing income and potentially engineering income. So, another piece of advice from me is be realistic as to what you can get. If you're getting something in the eights or the nines, there's probably a reason for it. Either the market thinks it's not sustainable, if it's a business, those earnings can't be replicated for many years to come, or there's something going on with the balance sheet of financial engineering which is spitting out that yield.

Sara Allen: What would be an average yield that you would think wouldn't ring those alarm bells that an eight or nine might?

Ben Clark: I guess where the markets are, I mean Mike will have an opinion on this as well, but if you can get 4% fully franked, that's a realistic yield. You can still buy good quality, growing businesses that are paying that sort of income. So if you can use those franking credits, you're getting 5.7%. It's not terrible given we're potentially going to go into a rate-cutting environment.

One thing I should add is the importance of dividend growth over time is really a big thing to look at. Sometimes you can buy stocks on low yields now, but fast-forward five or seven years and the yield could actually be really attractive versus what you paid. So companies like Soul Patts and Brickworks and these sort of businesses that have compounded dividend growth at 10, 12% per annum for years and years and years, don't be put off by initial starting low yield.

Return versus consistency

Sara Allen: How do you balance looking for return versus consistency of return?

Ben Clark: If you're looking for return, that's nice to get a good return, but I think again, if you're looking at a company, you need to make sure that it consistently can generate that return. Because as I said, if the starting number is high, then the market's probably in doubt about whether it's consistent. And so you need to do the work. Can, at worst, this company continue to pay a flat dividend for many years, or ideally grow it marginally? Because I can tell you if there's a lot of yield-hunters in a stock and that stock needs to cut that yield for whatever reason, it'll be a bloodbath, because that's what everyone was there for. So you need to make sure that doesn't necessarily have to happen.

Sara Allen: Are there any tips that you have for investors trying to take that approach of focusing on consistency rather than just returns?

Michael O'Neill: Yeah, I think starting with a quality business where you can look at the earnings and the sustainability, that they're not under cyclical or structural threats. Starting with a solid balance sheet. Avoiding businesses that have paid out too much of their earnings and neglected their franchise in the process. I think that puts you in a good stead to generate a sustainable yield.

Key risks for investors

Sara Allen: What are the key risks that you think income investors should be aware of coming into 2025?

Michael O'Neill: Well, always being aware of companies that are not quality to begin with and can't sustain or grow their dividends is key, and balance sheets is much a part of that. I do think there are some risks around earnings quality that we've briefly touched on. But I also think given that the banks have rallied as much as they have in the last year, that maybe the risk for income investors are a little different this time. Maybe 2025 is the year that valuations will start to matter. I don't want to ring the bell or anything. It's not clear what's going to cause volatility to come back in markets, but income investors concentrating in banks should be very wary of that.

Sara Allen: And Ben, are there any risks that you think investors just are missing, they haven't appreciated?

Ben Clark: There's always risks. Going back to engineered yield or package yield, I think is a risk in 2025. I definitely think when quality has run so hard, it would be very easy to create a low-quality but high-yielding portfolio which could set you up for a bad longer-term financial outcome. It's probably the biggest risk to me at the moment.

This is not an easy market, I would say. I mean, we're in a bull market. It feels good. But allocating to this market, I think Michael probably agrees, is difficult because momentum has taken over, and in some cases it feels like valuations and other measures have been thrown out the window. That won't last forever, but it can last longer than you expect.

Guest picks

Sara Allen: Let's take a look at some companies that have some strong income potential this year. We've asked our guests to bring along one income stock that they think is a core holding for 2025. Ben, we're going to start with you. What's your stock?

Ramsay CARES (RHCPA)

Ben Clark: The ticker code is RHCPA, and it's a Ramsay Health Care Preference share. So it's technically not a share. These were issued nearly 20 years ago, and have been trading on the market ever since. Back then, the preference share, or hybrid landscape, was very different to today. After five years, it was rolled. It had to kick up the interest payment that it was making, and it became perpetual in nature. So it's important for viewers to understand this is a perpetual security. There's no determined date it has to be bought back. Although, if you're buying it today, probably an outcome you don't want is for it to be bought back. So it's trading at about $107, and it would be bought back at $100 if that were to happen.

But they're paying 4.85% above the 180-day bank bill swap rate. They've done that consistently for 20 years. It puts them on a yield of 8.6% at current cash rates. So if those cash rates start getting cut, the income will also fall, but it'll still be good versus what you can get in cash. And it's got a great counterparty behind it. I mean, Ramsay has earnings issues at the moment we're all well aware of, but it's got great assets and it's a pretty safe company to effectively be lending money to.

Sara Allen: Now Michael, your turn. What's your income pick as a core holding?

Charter Hall Retail REIT (ASX: CQR)

Michael O'Neill: Well, we also own some Ramsay Preference shares. So I'm on board with you there. I'd say a real favourite is Charter Hall Retail REIT, CQR. It's a great example of a company paying a strong dividend yield, 7.5%, trading on a conservative discount to its net tangible assets, about 27% discount, and its assets are extremely high-quality. It owns a $4 billion portfolio of neighbourhood centres, which are backed by Coles, Woollies, Aldi, and they get turnover rent increases. And it also owns petrol stations that are anchored by BP, Ampol, where they get inflationary increments in their rent, and those have over a 10-year duration of their weighted average leases. Vacancies, importantly, are at quite low levels. So they're in a good position when leases roll. And they're actually actively selling down assets and reducing their gearing.

Sara Allen: Thank you both. That's all we have time for today, and we hope you've enjoyed this episode of Buy Hold Sell. If you'd like more from us, please subscribe to Livewire Markets website or YouTube channel, there's more coming. Till next time, have a good week.