Google Cloud revenue doubles, why does Goldman Sachs still cut its target price to $385?

TL;DR

· Google Cloud revenue grew about 103% year-over-year in Q3, with operating margin rising to 36.2%, driven significantly by enterprise AI demand and TPU system sales.

· Search and other revenue grew 12% year-over-year, below market expectations; exchange rates, changes in spending by some advertisers, and a high base collectively affect future 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 capital expenditure and depreciation burdens to continue weighing on cash flow, with free cash flow negative in 2026 to 2028 in its model.

· Goldman Sachs remains bullish on Google's user distribution, computing scale, and custom chip advantages, but lowered earnings forecasts and some valuation multiples.

Alphabet's AI business is accelerating revenue realization, and investment scale is expanding in tandem.

According to Goldman Sachs' commentary on Q3 2026 results, Google Cloud revenue doubled year-over-year, with margins improving 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, leaving investors 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 listed in the materials, the new target price implies about 18.5% upside.

Cloud business doubles, TPU sales become an important incremental driver

In Q3, Alphabet's consolidated total revenue was $127.577 billion, up 24.7% year-over-year, roughly in line with market expectations. But 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 a key driver of this growth. Among them, sales of Tensor Processing Unit (TPU) systems made a prominent contribution. 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 are currently using TPUs, and the related business is expected to further ramp up in the fourth quarter and in 2027.

This means Google's AI infrastructure is forming a new revenue stream through enterprise customer demand. Goldman Sachs remains bullish on the scaling opportunity for custom chips in both Google's internal use and external sales.

However, the cloud business beat has not yet eliminated profitability pressure at the group level. In the third quarter, Alphabet's operating profit was $40.576 billion, about 6.5% below market expectations. Google Services operating profit was $39.157 billion, also below expectations, and the strong performance of the cloud business was not enough to fully offset shortfalls in other businesses.

Search growth slows, AI monetization still needs validation

As the core revenue source, Google Search & 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 currency headwinds, while also mentioning specific changes in parts of the advertising industry: some Asia-Pacific retailers were affected by the EU's removal of the 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 that currency headwinds in the fourth quarter will 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 provides another line of observation. Management said AI is enhancing ad clicks and conversions 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 are 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 validated.

The subscription business provided some support. Goldman Sachs noted that subscription revenue is growing faster than the advertising business, driven primarily by demand for YouTube Music, Premium, and the AI bundle in Google One. The material cited management disclosure that YouTube Premium subscribers have exceeded 150 million.

Strong Demand for Computing Power, Cash Flow Pressure Extended

Demand growth also requires Google to continuously expand computing power supply.

Alphabet maintained its 2026 capital expenditure guidance of $195 billion to $205 billion, and expects 2027 capital expenditure to increase significantly compared to 2026. The company needs to simultaneously meet computing power demand from internal product development, external enterprise customers, and Gemini model research, making resource allocation and investment returns important variables.

Goldman Sachs expects Alphabet's capital expenditure to rise from approximately $203 billion in 2026 to approximately $350.4 billion in 2027, and further reach approximately $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 recorded in the income statement through depreciation and other means.

Goldman Sachs expects Alphabet's depreciation and amortization to increase from approximately $38.8 billion in 2026 to approximately $75 billion in 2027, reaching approximately $115.3 billion in 2028. Even if other expense growth slows, the depreciation burden will continue to rise.

According to Goldman Sachs' cash flow forecasts, free cash flow for 2026, 2027, and 2028 is 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 to see clearer evidence to judge how high a return on invested capital (ROIC) current spending can ultimately deliver, and how additional computing power translates into sustainable revenue and cash returns.

Maintain Buy, but Lower Earnings and Valuation

After the earnings report, Goldman Sachs lowered its Alphabet 2027 earnings per share forecast from $15.50 to $15.01, and its 2028 forecast from $19.15 to $18.53, reductions of approximately 3.1% and 3.3%, respectively.

The target price adjustment also reflects changes in valuation assumptions. Goldman Sachs employs an equally weighted combination of operating profit valuation and forward cash flow valuation, in which the valuation multiple of enterprise value relative to EBIT under US GAAP is lowered from 26x to 24x; the multiple and discount rate for the forward cash flow valuation portion remain unchanged.

The long-term logic for maintaining the Buy rating remains built on Google's distribution and computing power advantages. Google owns multiple billion-user products and can deploy AI capabilities directly into existing applications; large-scale computing power and custom chips both support product development and may improve efficiency, while also 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 near term, whether search revenue can remain resilient, how long high levels of investment will persist, and when free cash flow will recover remain key factors affecting valuation.

What needs continuous verification going forward is whether cloud business orders can convert into revenue and cash collections, whether AI search can form stable advertising monetization, and whether capital expenditure and depreciation growth can match business returns.

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