The item is defined as close price of the stock divided by the revenue per share of the company for the most recent financial year. The ratio indicates the number of number of units of stock price to be expended to purchase 1 unit of revenue per share. Suppose revenue of the company is Rs.100,000, shares outstanding is 500 and stock price is Rs.100. PS ratio is calculated as (100,000/500) / 100 = 2x. So it costs Rs.2 to purchase every Rupee of the company’s revenue.
PS ratio is a valuation ratio and is used in lieu of PE ratio. When a company is loss making, EPS becomes negative and calculating PE ratio is not possible. In such a scenario PS ratio can be used. Just as in PE ratio, PS ratio is used by comparing the ratio of 2 or more companies operating in the same sector. The lower the ratio, the more undervalued the company. However one has to understand the reasons behind undervaluation before deciding whether the stock has investment potential.