Entergy probably won't add much power to a portfolio

— -- A: You're already buying power from your local utility, should you also buy the stock?

You're asking about Entergy, which is an energy generation company that creates and sells electric power. It mainly deals electricity in Arkansas, Louisiana, Mississippi and Texas. But it also has a natural gas distribution business and produces and sells power in the northeastern U.S. from its nuclear power plants.

On the surface, the stock has a few things going for it, including a decent 2.9% dividend yield and a relatively healthy stream of revenue and earnings. The company's net income in the third quarter 2007, the latest available, rose 88% to $461.2 million.

But should you buy the stock? Whenever you consider buying an individual stock, you should put it through four important tests. You can look at past Ask Matt columns in the archives to learn how. But I'll show you, using Entergy as an example. Here goes:

Step 1: Risk vs. reward. When you take a risk on a stock, you want to make sure you're properly rewarded. Downloading Entergy trading history back to 1981, we see the company generated an average annual compound rate of return of 11.5%. Add the current dividend yield of 2.9% and that gives the stock a total long-term return of 14.4%. That is a solid return and 43% greater than the long-term average annual return of the Standard & Poor's 500 index.

But to get that return, you accepted risk — standard deviation of 28.4 percentage points. That's 48% more than than the S&P 500's long-term risk. Technically, you're not being compensated for the risk you're taking. But, we'll let the stock slide since the risk and return are relatively close.

Step 2: Measure the stock's discounted cash flow. Some investors decide if a stock is pricey by comparing its current price to the present value of its expected cash flows. It's a complicated analysis made simple with a system from NewConstructs. When we run Entergy's stock, we find it's rated "dangerous." In other words, the current stock price is greater than what the company is expected to generate in cash over it's lifetime. If you're looking for a bargain, you're not getting it with Entergy at these prices.