In a recent article I tried to answer a question I hear frequently. Is it feasible to retire off dividends alone. In response to my article, I heard numerous success stories from retirees. These are real life examples of the premise of my article. You can retire off dividends. However, I looked at the risks of this income investing strategy and offered some suggestions.

To do so requires understanding the factors that lead to growth in passive income which I’ve covered in an article on how to build $100,000 in passive income. 

A focus of both articles was the Australian share market and the advantages and disadvantages of building a portfolio heavily tilted toward Aussie shares. The advantage is obvious. Australian companies pay a higher percentage of profits in dividends and therefore have a higher yield than most foreign markets. The tax advantages from franking credits make investing in Aussie companies even more attractive.

While acknowledging these inherent advantages to investing domestically I looked at two potential issues for retirees or anyone trying to build passive income. The first was the concentration of the Aussie market in certain companies and in the financial services and basic materials sectors. The second was the lower historic growth in local dividends when compared to global markets.

I thought it would be worthwhile to look at the top contributors to the overall income in the Aussie market. These are companies that many income investors gravitate towards. A passive investor buying the index would receive a large portion of their income from these shares.

Our analysts project future dividends for each company they cover. Those estimates provide the opportunity to explore the estimated forward dividends for the ten biggest contributors to income generated from the ASX 200. In total these 10 companies pay out just under 60 percent of the total dividends an ASX 200 investor would receive.

As you will read in the summary for each of the companies the future outlook for dividends is not great for the top 10 dividend payers in Australia. While the average yield of these 10 shares is 5.30% our analyst do not forecast significant growth during the next 5 years for many of the names on the list.

I’m an advocate for investors to build portfolios that mix both high current yields and future growth. Both are required to build a sustainable and growing stream of passive income. Investors may need to turn elsewhere for growth. A point illustrated in my colleague James Gruber’s recent article on 11 ASX dividend paying shares for the next decade which includes few of the top-10 ASX dividend shares.  

The following chart shows the top 10 contributors to overall ASX 200 dividends with their current yield, the growth in dividends since 2013 and our analyst’s view on projected growth over the next 5 years.

Dividend growth prospects

The following is a brief overview of the top 5 largest contributors to overall ASX 200 dividends. You can read about the next 5 highest contributors in part 2 which is available here. 

BHP (BHP: ASX)

BHP is the heavyweight of the ASX and makes up a little more than 10% of the ASX 200. This influence is even more pronounced with dividends as BHP paid out over 17% of the total income produced by ASX 200 shares.

BHP dividends have dropped in fiscal year 2023 and 2024 after two strong years of dividends. Since 2013 BHP’s dividends has grown at a compounded annual growth rate (“CAGR”) of slightly less than 3% although the dividend is volatile as BHP’s fortunes rise and fall with commodity prices.

The dividend growth prospect don’t look too promising in the future based on Morningstar analyst Jon Mills’ projections. Over the next 5 years he expects the dividend to shrink as opposed to returning to the post-COVID heights in 2021 and 2022.

One piece of good news for BHP shareholders is that the company is in strong financial shape with modest debt levels. This financial flexibility should allow BHP to continue to return cash to shareholders provided earnings hold up.

Commonwealth Bank of Australia (ASX: CBA)

CBA is another dividend heavyweight in the ASX and makes up a little over 8% of total ASX 200 dividends. CBA’s dividend was 17% higher in 2023 than the previous year and grew slightly in 2024.

Since 2013 the dividend growth at CBA has been slow with a CAGR of less than 2%. The outlook for future dividends is more positive going forward as Morningstar analyst Nathan Zaia sees a growth rate over the next 5 years of more than 3.5% per year.

CBA is committed to maintain capital above the regulatory minimum and does not intend to spend money on expensive or dilutive acquisitions or risky expansion plans. The bank is currently sitting on $3.1 billion in surplus capital which is above the top-end of CBA’s target range. That leaves plenty of cash for dividend payments and Zaia thinks the bank’s target dividend payout ratio of 70%-80% is reasonable.

Rio Tinto (ASX: RIO)

Much like BHP, Rio Tinto shareholders have experienced a significant drop in dividends following the spike in commodity prices in 2021 and 2022. However, the growth since 2013 has been more impressive with a CAGR of just under 7.75%.

Rio Tinto’s balance sheet is sound, and we expect the company to run a relatively conservative balance sheet for the foreseeable future. Morningstar analyst John Mills expects dividends to continue to trend lower over the next 5 years with a reduced payout in 2025 and 2026.

Rio is heavily dependent on China and Mills expects earnings to materially decline with demand for many commodities likely to soften with the end of the China boom. In particular Mills is forecasting lower demand for iron ore which has disproportionately benefited from the boom in infrastructure and real estate investment.

National Australian Bank (ASX: NAB)

National Australia Bank is well-capitalised, which supports Morningstar analyst Nathan Zaia’s modest dividend growth forecasts while supporting a buffer for a larger-than-expected rise in credit stress.

Since 2013 the CAGR of the dividend was just over 1%. Zaia forecasts a near-70% dividend payout ratio going forward and expects dividends per share to remain flat over the next 5 years. He thinks NAB has set an appropriate dividend payout range considering the capital position, outlook for loan growth, M&A opportunities, and loan loss provisions. COVID-19 was an opportunity for the bank to reset shareholder expectations and Zaia believes NAB won’t revert to its old aggressive payout ratios.

In the past NAB paid out too much of earnings in dividends and subsequently required equity raisings. The bank paid out close to 100% of earnings in fiscal 2018 and 2019. Even more recently, when National Australia Bank raised $4 billion in equity at a dilutive discount to Zaia’s fair value estimate, he thought it was counterintuitive to then pay dividends totalling $2 billion in fiscal 2020.

Woodside (ASX: WDS)

Woodside’s dividends have been strong after energy prices increased following a COVID related slump. However, looking back since 2013 the dividends have a CAGR of negative 2.5%.

Woodside is another example of a company highly reliant on commodity prices and large capital expenditures are required to maintain and grow production.

Woodside maintains a sound balance sheet although Morningstar analyst Mark Taylor believes that a payout ratio of 80% is too high. Woodside has had an 80% payout ratio since 2013 while LNG expansion plans have been on hold. The official policy is to maintain a minimum 50% payout of underlying earnings.

While Taylor believes it is appropriate to distribute funds if capital expenditures aren’t going to be undertaken, he thinks a better use of cash would have been to accelerate growth plans. Despite his misgivings Taylor notes that strong cash flows and a healthy balance sheet should support ongoing dividend payments.

Over the next 5 years Taylor expects dividends to grow less than 2% per annum. 

Final thoughts

Many investors are tempted by high yields and fully franked dividends. These can be positive traits for an investment. However, relying solely on high yields as a deciding factor for an investment can cause an investor to fall victim to a dividend trap. This is a topic I covered in an article on the biggest mistakes income investors can make.

A dividend trap is not the only pitfall for an income investor. A lack of dividend growth can also be an issue. For younger investors poor dividend growth prospects may detract from building a meaningful passive income stream. For older or retired investors, a lack of growth may mean deteriatring standards of living if inflation surpasses dividend growth.

Investors looking for growth may want to consider moving away from the largest ASX companies with high yields and consider other opportunities including smaller ASX listed opportunities and global shares. 

Part two of this article is available here.

For more resources on dividends listen to our podcast episode on structuring your portfolio for income. 

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