Revenue grew 25%—why does Goldman Sachs expect a negative market reaction?

  • Alphabet’s third-quarter total revenue was 127.58 billion dollars, up 25% year over year; it was slightly above Goldman Sachs’ estimate of 127.49 billion dollars and slightly below the Wall Street estimate of 127.75 billion dollars compiled by Visible Alpha.
  • Goldman Sachs is more focused on the revenue mix: search and other revenue fell short of Goldman Sachs and FactSet expectations, and the Google Services margin was also below the bank’s estimate. Although cloud exceeded analyst expectations, it did not meet the expectations of more optimistic investors.

How did search and cloud differ?

  • Search and other revenue was 63.35 billion dollars in the third quarter, up 12% year over year. Goldman Sachs believes the miss could raise questions about the search growth trend and the impact of search activity shifting toward a broader range of AI interfaces and query methods.
  • Google Cloud revenue was 30.71 billion dollars, up 103% year over year, exceeding Goldman Sachs and Wall Street estimates but falling short of some more optimistic investors’ expectations. Cloud operating profit was 11.12 billion dollars, and its margin was better than Goldman Sachs expected; management had previously warned of margin pressure in the second half.

Why did revenue growth not translate into the expected profit?

  • Third-quarter operating profit under US generally accepted accounting principles was 40.58 billion dollars, below Goldman Sachs’ estimate of 43.35 billion dollars and Wall Street’s estimate of 43.41 billion dollars; the operating margin was 32%. The Google Services margin was below Goldman Sachs’ estimate, while the cloud margin was better than the bank expected.
  • Earnings per share were 2.12 dollars, below Goldman Sachs’ estimate of 2.96 dollars and Wall Street’s estimate of 2.95 dollars; earnings per share and net income for the quarter were affected by fluctuations in the value of equity holdings.

What matters for capital spending and the outlook?

  • Third-quarter capital expenditure was 51.4 billion dollars, below Goldman Sachs’ estimate of approximately 60 billion dollars. Goldman Sachs is watching how the company allocates additional investment amid constrained computing capacity, the returns on that investment, and when the capacity constraints will ease.
  • Goldman Sachs has a buy rating on Alphabet and a 12-month price target of 435 dollars. Risks listed by the bank include industry changes disrupting search monetization and heavy investment putting pressure on operating margins for longer than it forecasts.