Before you defend a DCF in a meeting, you put it through five sanity checks. Each one cross-references your DCF against an external reference point, and any one of them throwing a discordant signal means you go back to the model.
Implied EV/EBITDA
Compute the implied EV/EBITDA at your DCF answer (EV from the DCF ÷ year-1 EBITDA). Compare to the comparables. If your DCF implies 18x and the comps trade at 10x, your DCF is high — either your forecast is too aggressive, your terminal value is too generous, or your WACC is too low. Conversely, an implied 6x against 10x comps is suspiciously cheap.
Implied EV/Sales
Same exercise with EV/Sales. Particularly useful for businesses where margin is volatile or near zero — early-stage SaaS, miners, transport. The EV/Sales implied by your DCF should be in the same neighbourhood as comparable businesses at similar growth-and-margin profiles.
Implied perpetual growth
If you used the exit-multiple method for terminal value, back out the implied perpetual growth rate using the Gordon-growth formula in reverse. If your TV multiple implies g = 8%, that is unrealistic — long-run growth above 5% in nominal terms is rare for any business. The reverse check often reveals an over-aggressive TV that the multiple alone hid.
Cross-check against precedent transactions
If similar businesses have been acquired recently at certain multiples, your DCF should land in the same neighbourhood — adjusted for control premium (typically 20-30% above public market multiples). A DCF below precedent transactions on a controlling-stake basis is suspicious and may need a strategic-value adjustment.
Cross-check against the implied IRR
Solve for the IRR that equates the DCF price to the cash flows. This is what the equity holder would earn if your forecast is exactly right. Compare to your cost of equity. If implied IRR equals Ke, your DCF says the stock is fairly valued. If IRR > Ke, undervalued. If IRR < Ke, overvalued.
If three out of five disagree, your model is wrong
A single sanity check disagreeing with the DCF is not a problem — it might just reflect a mispriced peer. Three or more disagreeing means your model is wrong somewhere. The most common culprits, in order: terminal-value assumption, WACC build, year-5 margin assumption.
Exercise
Your DCF on a Kenyan-listed bank produces an intrinsic value per share of KES 75. Current market price is KES 40. Run the sanity checks: (1) Year-5 P/E implied by your DCF is 18x; comparable Kenyan banks trade at 6-8x P/E. (2) Implied P/B is 2.5x; peers are at 1.2x. (3) Implied perpetual growth (backed out from exit multiple) is 7%; long-run Kenyan nominal GDP growth is around 10%. (4) Precedent transactions in African banking have happened at 1.5-2.0x P/B with 20-30% control premiums. (5) Implied IRR at current market price is 32%; your Ke is 24%. Walk through what each check says, identify the most-likely error in your model, and recommend what to do next.