How to generate passive income in 2024

Over the 12 months to the end of December, housing costs rose 6.1%, alcohol and tobacco prices lifted 6.6%, medical costs bumped up 5.1%, and insurance and financial services prices soared 8.1%. We also spent more on food and non-alcoholic beverages, more on transport, and more on education.*

All this is to say that it costs a lot more to be alive today than it did 12 months ago, and this anonymous writer is starting to feel the bite. Sure, inflation is finally starting to cool, but you would be hard-pressed to find someone whose lifestyle hasn't been dampened by higher rates. 

So this episode of Buy Hold Sell is focused on making your money work a little harder for you. 

We've reached out to two income specialists in the form of Dr Don Hamson from Plato Investment Management and Michael O'Neill from IML, for their top tips and tricks for helping you generate more bang for your buck in 2024.

They share the stocks that have sustainable yields, name a few that don't, teach you how to avoid the traps that plague dividend-hungry investors, and last but not least, name one stock that they believe every income investor should hold in 2024.

Note: This episode was filmed on Wednesday 14 February 2024 and first appeared on Livewire Markets. You can watch the video, listen to the podcast or read an edited transcript below. 

*According to the Australian Bureau of Statistics. 

Edited Transcript 

 Ally Selby: Hello and welcome to Livewire's Buy Hold Sell. I'm Ally Selby and today we are learning how to generate a little bit more bang for your buck. Everything is so much more expensive today. Think rent, groceries, electricity… so let's put a little bit more dosh in your pocket.

We're joined by two income experts. We've got Don Hamson from Plato Investment Management and Michael O'Neill from IML. We're going to be learning how to generate passive income in 2024.

Let's get straight into it. Yields look like they have peaked or are peaking. Michael, I might start with you. What does that mean for investors?

Michael O'Neill: We're in a tricky spot in the cycle, Ally. The market's expecting yield cuts in the back half. For the US, until very recently, there were six rate cuts baked in for the second half. But if you look at where earnings expectations are for the equity markets, we've still got expectations for over 10% earnings growth.

So, there's a real incongruency there for me and for investors in looking at equity markets as a source of income. On the one hand, you don't want to be overly exposed to growth stocks that are vulnerable should the economic scenario not paint as quite as rosy a picture as the market is suggesting. On the other hand, you have to be careful with the cyclical stocks whose earnings might be challenged.

Where we see really good opportunities for income from equities is in your low-risk industrial stocks, the stocks that are less dependent on the cycle, playing out in a certain way in order to generate their income.

Ally Selby: How about you, Don? What's your outlook on income equities in 2024?

Dr Don Hamson: We think there'll still be solid income there. It's amazing, a lot of the stocks that people were expecting to disappoint, like a lot of the consumer discretionaries, have actually surprised on the upside. The earnings are off a little bit, but they've actually done very well. We are still forecasting that we'll get about a 9% yield out of our portfolio this year.

Ally Selby: This question's a little bit redundant then.

Dr Don Hamson: Including franking credits.

Ally Selby: Including franking credits. My next question was: TDs are yielding around 5% right now, that's term deposits, should investors even risk their money on equities?

Dr Don Hamson: That's up to the individual investors as to their risk tolerance, et cetera. The yield on the equity market itself is around 6%, including franking credits. And if you tilt towards high-yield stocks, as we do, or actively trade them, you can generate certainly much more income than that.

And there are no franking credits on your 5% term deposit. That's worth a 5% cash yield. On a fully-franked dividend, it's worth about 2%. So, if you can get 5% cash yield on a stock, it's really worth 7%, not 5%.

Ally Selby: I'm guessing you probably agree, Michael?

Michael O'Neill: I agree with a lot of what Don said. I'd add a couple of things. With TDs you have the issue of liquidity and early redemption. I think, for us, the key message whether you're choosing asset classes or investing in equities, is diversification. I take Don's point that if you start with a strong base of good dividend-paying stocks, hopefully, sustainable yields based on the cash flows and the balance sheet, not looking to those more cyclical, more discretionary spaces where dividends could be challenged, you can add franking certainly to the equation.

You also have option income, which is something people are less aware of, but can sustainably deliver 2-3% per annum. And if you do it in a way that maybe is careful in not to crimp your capital upside too much, you can have an income stream which is steady and growing. It's important for people who are looking to live off their income.

Ally Selby: Our readers love a stock pick. I'm going to ask you for two, but I want one where the yield is sustainable and one where it's unsustainable.

Region Group (ASX: RGN) and BHP Group (ASX: BHP)

Michael O'Neill: I think a topical place to start is the property sector. One property stock where the yield is sustainable is Region. You've got a business where the majority of your rent is coming from large, and in many cases non-discretionary, anchor tenants. You've got enviable retention at over 90%, and you're also getting underlying growth of around 3% in rent.

Sure, there'll be a step up in debt costs that we'll have to wash through that's being covered by the rent increases, but at the same time, they're selectively selling down assets to reduce debt.

Ally Selby: And one where it's unsustainable?

Michael O'Neill: I'd have to call out the elephant in the room, BHP. It’s over 10% of our index and has been a big component of dividends. I think it's just over 5% today. But if you look longer term at what might be a sustainable iron ore price, we've seen it spike to dizzying highs of $160 per tonne. It's back in the $130 range or thereabouts.

And ultimately, when the supply and demand imbalance corrects, it puts not only your dividend, but also potentially your capital at risk.

Ally Selby: Over to you, Don. Do you agree, BHP and Region? What's your sustainable and unsustainable peaks?

National Australia Bank (ASX: NAB) and Pilbara Minerals (ASX: PLS)

Dr Don Hamson: I think in the short term, BHP's yield is going to hold up pretty well. And we are quite short-term in the way that we've used stocks - you don't have to hold them for five or 10 years. And in commodity prices, it's obviously very cyclical.

I'm just going to go to a very boring one and say some of the banks have got pretty good yields, 7-8% when you include the franking credits. You've got something like a NAB, which is performing pretty well. Not quite fully franked, but still a pretty good yield - so that'd be my buy.

There are resource stocks that I think are definitely unsustainable in the short term, and that's obviously anything that's a lithium or nickel miner that's been paying yields. Look at Pilbara: Currently trading on a 10% gross yield based on last year's dividends. But obviously, lithium prices have absolutely been smashed recently. That is, to me, unsustainable.

I think you've got to realise when you're going into resource stocks, that they are cyclical. You can make some good money in the short term, but you do have to have your eye on what a commodity price is doing.

Ally Selby: Looking out over the rest of 2024, are there any risks that you think investors should be aware of?

Dr Don Hamson: There are always risks. There are heaps of risks. Michael's already said one. People are baking on interest rate falls but if inflation remains sticky, then maybe interest rates won't come down, and we could still have a hard landing. I doubt it, to be honest, because actually inflation surprised on the lower side in the December quarter.

I've already mentioned lithium and nickel prices have come off big time in the last six months. They're actually quite a small part of our index though. I'd be much more worried if iron ore prices came off 20 or 30%, but at the moment they are remaining pretty sticky.

Ally Selby: Over to you, Michael. Are there any income traps that you think investors should be aware of in 2024?

Michael O'Neill: There's always the trap of investing in companies with under-sustainable payout ratios, and I think that's ever present, and particularly given not all companies have refinanced their debt or are baking in higher interest costs in their debt. You've got to be quite wary of that. I take Don's point about looking at the commodity space. BHP is such a big contributor to index dividends, we've got to be careful.

I agree, I think lithium is the space where... you've seen 50% fall in the last quarter in prices. If you take IGO, Mineral Resources, and Pilbara, their dividends are off 70%. I think commodities is where we're most cautious.

Ally Selby: Obviously both our guests run diversified portfolios, as you should too, but I have a little bit of a challenge for Don and Michael today. I've asked them to select one stock, and one stock alone, that they could hold or they would hold if they had to in 2024, just for income alone. Michael, what have you chosen?

Charter Hall Long WALE REIT (ASX: CLW)

Michael O'Neill: My favourite income stock is Charter Hall REIT. That's the Long WALE REIT. It's got over a decade-long, weighted average lease. It's got an enviable book of tenants on the non-discretionary side, so neighbourhood shopping centres, Woollies, Coles, Aldi, and petrol stations. The rent grows in the neighbourhood centres with turnover and in the petrol stations with CPI triple net leases.

They've also got, on their $4 billion portfolio, a program of selling down assets to reduce debt. So again, while they weather higher interest costs in the short term, you should actually see some growth in that yield as you look through.

Ally Selby: Over to you, Don. What's your one stock you would own, if you had to, only one stock? I know you run a diversified portfolio. What's the one stock you'd in 2024 for income?

Dr Don Hamson: It does go completely against my training, and probably Michael's as well, that you want to diversify a portfolio, and not put all your eggs in a basket. We actually have about 90 stocks in our portfolio, believe it or not.

Ally Selby: Wow.

Dr Don Hamson: One or two of the banks are actually going to pay you good, solid dividends and those franking credits. We prefer stocks with paying franking credits, rather than the REITs or the unfranked ones.

Ally Selby: I'm going to push you for one stock. What banking stock would you choose, if you had to, over in 2024?

National Australia Bank (ASX: NAB)

Dr Don Hamson: Okay, I'll push NAB.

Ally Selby: And why?

Dr Don Hamson: It's got good results at the moment. It's getting its act together. Its business banking is very, very strong. I think that they're getting it there and it's a reasonable valuation, whereas CBA is way too expensive.

Ally Selby: I hope you enjoyed that episode of Buy Hold Sell as much as I did. If you did, why not give it a like? Remember to subscribe to our YouTube channel. We're adding so much great content, just like this, every single week.