IML's Michael O'Neill's 5 key ASX dividend picks and the outlook for income

Income from the ASX can look thin at the index level. On IML’s numbers, the forward yield is around 3.3%, well below what many investors have historically expected from Australian shares.

But that headline misses what is happening beneath the surface. Dr Michael O'Neill, Portfolio Manager at IML says the ASX remains flush with income opportunities, provided the focus stays on dividend sustainability, balance sheet strength, and sensible entry prices, rather than simply chasing the biggest yield on offer.

O’Neill brings an actuary’s discipline to markets, a mindset built around risk, probabilities, and how portfolios behave when conditions shift.

Since 2011, the IML Equity Income Strategy has delivered 9.5% average income including franking, versus 5.9% from the ASX 300, and with less severe drawdowns along the way.

In this episode of The Rules of Investing, O'Neill reveals the sectors most likely to deliver above-market income, his framework for assessing dividend quality and sustainability and a selection of his preferred dividend names from the ASX300. 

Click on the player to listen or read a summary of the discussion below. 

Prices up, yields down

The first point is simple. Yields have drifted lower because valuations have risen faster than dividends.

“Valuations are up, dividends are down. That’s the simple answer.”

That is happening for two reasons. First, the market’s composition has changed, with larger parts of the index now sitting in lower yielding or no yield areas. Second, even in the traditional dividend engine room, the banks, share prices have often outpaced dividend growth, pulling yields down.

On O’Neill’s numbers, utilities sit at the higher yielding end of the market, energy is also higher yielding at around 4.6%, while consumer discretionary is lower at around 2.5% and IT is lower again at less than 0.5%.

At just over 3% the index yield may look low, but the ASX still offers plenty of ways to build an income portfolio - it simply requires a more active approach.

Sustainability first, then yield

A recurring message from O'Neill is that income investors need to underwrite the business before falling in love with the yield.

“Sustainable and hopefully growing dividends is our number one priority and we’ll never compromise on that.”

In practice, that means focusing on the drivers of dividend durability, recurring cashflows, sensible payout ratios, balance sheet strength, and a business model that can cope with tougher conditions.

It also means accepting that the “best” dividend portfolio will not always be made up of the highest yielding stocks. There can be a role for quality companies with lower starting yields but stronger growth and O'Neill has the ability to use options as an income enhancing strategy from companies with a stable growth outlook.

Five key dividend picks

O’Neill’s dividend ideas aren’t built around a single theme like “highest yield”. They're built around cashflows that can keep showing up, even if the cycle turns and markets get jumpy.

At the more defensive end sits Dalrymple Bay Infrastructure (ASX: DBI). The appeal is structural. The business gets paid for availability rather than being hostage to volume swings, which is exactly the kind of setup income investors tend to value when certainty is scarce.

“They get paid regardless of the volumes.”

For listed property, the preference was Charter Hall Retail REIT (ASX: CQR). O'Neill says neighbourhood centres anchored by everyday spending can be steadier than the market gives them credit for. With rates no longer falling neatly, the balance sheet matters more, and the focus stays on assets with resilient occupancy and income that can hold up through different conditions.

Then there are the quality businesses that might not scream “income stock” at first glance, but can still earn a place in an income portfolio when the price is right.

*CSL (ASX: CSL) is a good example of what was once viewed as a growth stock falling into the crosshairs of an income investor. The point here is the cash generation and the market’s tendency to extrapolate near term issues too far into the future. When valuations reset, as they have with CSL, yield can quietly become more attractive.

Amcor (ASX: AMC) and Brambles (ASX: BXB) are two examples of businesses where the dividends can be less volatile than the share price. That matters because a steady payout can do real work in a portfolio, not just as income, but as a behavioural anchor when markets swing between confidence and anxiety.

A word of warning on interest rates

Hotter than expect inflation prints have thrown a spanner in the works for the RBA and O'Neill  believes markets are still pricing in a friendlier rate path than may arrive. That is not a prediction about where rates go next, it is a reminder about what happens when portfolios are built on optimistic assumptions. 

When valuations are high, the margin for error is thinner, and rate sensitivity becomes a bigger driver of returns, even for businesses that look defensive on the surface.

“The implications of underestimating rates are significant.”

For income investors, the message is simple. Yield alone is not protection. What matters is whether the dividend is funded by repeatable cashflows, whether the balance sheet can handle refinancing pressure, and whether the valuation leaves room for things to be merely okay rather than perfect.

O'Neill's dividend pick for the next five years

When pushed to nominate one business to own for the next five years, the choice was Steadfast Group (ASX: SDF).

Brokers sit in the distribution lane rather than taking underwriting risk, and as insurance becomes more complex, advice and access become more valuable. Steadfast’s scale adds another layer, with the ability to keep consolidating a fragmented market while benefiting from sticky client relationships.

O’Neill also pointed to the company’s 95% retention rate, and a runway of acquisitions that can support earnings and dividend growth over time.

“I’d certainly be happy to buy it today, put it in the bottom drawer, come back in 2030.”

*Correction - in the podcast Michael mistakenly said the yield on CSL is 4% when it is actually closer to 3% based on 1-year forward estimates from brokers.