TL;DR
· Google's third-quarter cloud business revenue grew approximately 103% year-over-year, with operating margin rising to 36.2%, as enterprise AI demand and TPU system sales became important drivers.
· Search and other revenue grew 12% year-over-year, below market expectations; exchange rates, changes in spending by some advertisers, and a high base together affect subsequent growth.
· The company maintained its 2026 capital expenditure guidance of $195 billion to $205 billion and expects investment to increase significantly in 2027.
· Goldman Sachs expects that capital expenditure and depreciation burdens will continue to weigh on cash flow, with free cash flow in its model negative for 2026 through 2028.
· Goldman Sachs remains bullish on Google's user distribution, computing scale, and custom chip advantages, but has lowered earnings forecasts and some valuation multiples.
Alphabet's AI business is accelerating revenue realization, and the scale of investment is expanding in tandem.
According to Goldman Sachs' commentary on third-quarter 2026 results, Google Cloud revenue doubled year-over-year and margins improved significantly, showing that enterprise AI demand is translating into actual business growth. However, search revenue came in below expectations, and management expects capital expenditure to increase substantially next year, so investors still need to judge whether cloud growth can cover rising infrastructure costs and to what extent AI can enhance search's long-term monetization capability.
Goldman Sachs maintained its "Buy" rating on Alphabet while lowering its 12-month target price from $435 to $385, a reduction of about 11.5%. Based on the October 28, 2026 closing price of $324.89 cited in the materials, the new target price implies upside of about 18.5%.
Cloud business doubles, TPU sales become an important incremental driver
In the third quarter, Alphabet's consolidated total revenue was $127.577 billion, up 24.7% year-over-year, broadly in line with market expectations. However, performance varied significantly across businesses.
Google Cloud revenue reached $30.709 billion, up 102.6% year-over-year, 3.9% above Goldman Sachs' forecast and 5.7% above the market consensus. Cloud operating income was $11.121 billion, with operating margin rising to 36.2%, above the market expectation of 33.3% and up about 12.5 percentage points year-over-year.
Enterprise AI demand is an important driver of this growth. Among these, sales of Tensor Processing Unit (TPU) systems contributed prominently. TPU is a specialized chip designed by Google for machine learning computing that can support model training and inference. According to management disclosures in the materials, nearly 100 customers currently use TPUs, and the related business is expected to scale further in the fourth quarter and in 2027.
This means Google's AI infrastructure is forming a new revenue source through enterprise customer demand. Goldman Sachs remains bullish on the scale-up opportunity for custom chips in both internal use and external sales at Google.
However, the cloud beat has not yet eliminated profitability pressure at the group level. In the third quarter, Alphabet's operating income was $40.576 billion, about 6.5% below market expectations. Google Services operating income was $39.157 billion, also below expectations, and the strong cloud performance failed to fully offset the shortfall in other businesses.
Search growth slows, AI monetization still to be proven
As the core revenue source, Google Search and other revenue in the third quarter was $63.350 billion, up 12% year-over-year, 2.4% below the market consensus, and up only 0.1% quarter-over-quarter.
Goldman Sachs mainly attributed the slowdown in search this quarter to exchange-rate headwinds, while also mentioning specific changes in some advertising industries: some Asia-Pacific retailers were affected by the EU's removal of the minimum de minimis exemption, while advertising spending in media and entertainment returned to normal after the World Cup ended.
The comparison base for the fourth quarter is also more challenging. Since the third quarter of 2025, search revenue growth began to accelerate, meaning subsequent year-over-year performance will face a higher bar. Management also expects exchange-rate headwinds in the fourth quarter to be slightly greater than in the third quarter.
YouTube advertising also came in below expectations, with third-quarter revenue of $11.207 billion, up 9.2% year-over-year, about 2.1% below the market consensus.
AI's improvement of the advertising business offers another line of observation. Management said AI is improving ad click and conversion performance and strengthening personalization capabilities; advertiser adoption of tools such as AI Max and Performance Max (PMax) is also rising.
On the search experience side, management said most queries in AI Mode represent new demand and occur at an earlier stage of consumer decision-making. Such queries are expected to bring subsequent commercialization opportunities, but from usage growth to advertising revenue, the conversion path and monetization efficiency still need to be verified.
The subscription business provides some support. Goldman Sachs noted that subscription revenue is growing faster than the advertising business, mainly driven by demand for YouTube Music, Premium, and AI plans in Google One. The materials cited management disclosure that YouTube Premium has more than 150 million subscribers.
Strong computing demand, cash flow pressure extended
Demand growth also requires Google to continuously expand computing supply.
Alphabet maintained its 2026 capital expenditure guidance of $195 billion to $205 billion and expects 2027 capital expenditure to increase significantly compared with 2026. The company needs to simultaneously meet computing demand from internal product development, external enterprise customers, and Gemini model research and development, making resource allocation and investment returns important variables.
Goldman Sachs expects Alphabet's capital expenditure to rise from about $203 billion in 2026 to about $350.4 billion in 2027 and further to about $415.2 billion in 2028. The above figures are Goldman Sachs forecasts; the specific amounts for 2027 and 2028 are not company guidance.
Infrastructure investment affects financial performance through two paths: construction and procurement first consume cash, and after assets are put into use, related costs are gradually recognized in the income statement through depreciation and other means.
Goldman Sachs expects Alphabet's depreciation and amortization to increase from about $38.8 billion in 2026 to about $75 billion in 2027 and reach about $115.3 billion in 2028. Even if the growth of other expenses slows, the depreciation burden will continue to rise.
According to Goldman Sachs' cash flow forecasts, free cash flow in 2026, 2027, and 2028 will be approximately negative $12.6 billion, negative $40.6 billion, and negative $15.2 billion, respectively. Free cash flow is the balance of cash generated from operating activities after deducting capital expenditure; this forecast means that, in Goldman Sachs' model, infrastructure investment in the coming years will exceed operating cash flow over the same period.
Investors need clearer evidence to judge how high a return on invested capital (ROIC) current spending can ultimately generate, and how new computing capacity will translate into sustainable revenue and cash returns.
Maintain Buy, but lower earnings and valuation
After the earnings report, Goldman Sachs lowered its 2027 earnings per share forecast for Alphabet from $15.50 to $15.01 and its 2028 forecast from $19.15 to $18.53, reductions of about 3.1% and 3.3%, respectively.
The target price adjustment also reflects changes in valuation assumptions. Goldman Sachs uses an equally weighted combination of operating income valuation and forward cash flow valuation, in which the valuation multiple of enterprise value relative to US GAAP EBIT was reduced from 26x to 24x; the multiple and discount rate in the forward cash flow valuation portion remain unchanged.
The long-term logic for maintaining the Buy rating is still based on Google's distribution and computing advantages. Google owns multiple billion-user products that can deploy AI capabilities directly into existing applications; large-scale computing and custom chips both support product development and may improve efficiency while serving external enterprise demand.
Goldman Sachs judges that as AI commercialization expands from the infrastructure layer to the platform and application layers, the value of these capabilities may still be underestimated. But in the short term, whether search revenue can remain resilient, how long high investment will last, and when free cash flow will recover remain key to valuation.
What needs continuous verification going forward is whether cloud business orders can translate into revenue and cash collection, whether AI search can form stable advertising monetization, and whether capital expenditure and depreciation growth can match business returns.
