Alphabet’s third-quarter search growth slows as cloud revenue doubles: Why is AI growth still weighing on profit expectations?
Year-over-year search revenue growth fell from 17% to 12%, while rising AI search usage is temporarily weighing on monetization; cloud revenue grew 103%, but computing costs and capital expenditure are pressuring profits and cash flow. Bernstein lowered its price target to $325.
Original source：BernsteinFirst published on Unhidea：Original source date：
Key takeaway
Bernstein is optimistic about Alphabet’s AI opportunity, but slowing search monetization, pressure on cloud margins and heavy investment have led it to maintain its Market Perform rating.
Search volume hits a record high: Why is revenue growth slowing?
In the third quarter of 2026, Alphabet’s total revenue rose 25% year over year to approximately $127.6 billion; search and other revenue grew 12% to $63.4 billion, with growth slowing by 5 percentage points from the second quarter and revenue coming in approximately 2% below market consensus. Search is also slowing on a two-year cumulative growth basis.
Bernstein estimates that foreign exchange headwinds and a higher comparison base in the prior-year period explain more than half of the slowdown; changes in European tariff policy affected Asia-Pacific advertisers and added a drag of approximately 1 percentage point. The timing difference associated with World Cup and Prime Day advertising spending in the second quarter was also a factor.
Search query growth reached its highest level in five years, but AI Mode currently monetizes each query at a lower rate than traditional search, and its rapid growth is weighing on search revenue in the short term. The company is expanding advertising in AI Overviews, AI Mode and multi-turn conversations; Bernstein believes AI could expand the search market, while revenue improvement depends on monetization progress in these new settings.
Cloud revenue doubles: What could affect the durability of growth?
Third-quarter Google Cloud revenue rose 103% year over year to $30.7 billion, approximately 6% above market consensus but below the growth of more than 115% expected by some buy-side investors. AI infrastructure, AI solutions and the core cloud business all contributed, with TPU system sales a major driver.
Cloud backlog grew from $514 billion in the second quarter to $561 billion, with most still coming from traditional GCP contracts; the company expects to recognize slightly more than 55% of it as revenue over the next 24 months. Management expects TPU system sales to continue expanding in the fourth quarter and revenue growth to be more pronounced in 2027.
Management said cloud growth remained strong excluding TPU, but Bernstein noted a lack of specific quantified information on TPU customer concentration, non-TPU growth and TPU margins. These figures affect assessments of the durability of cloud growth.
Cloud margins rise: Why are company-wide profits still under pressure?
Third-quarter cloud operating margin rose to 36.2%, above 35.6% in the second quarter and 23.7% a year earlier. However, third-party cloud capacity used to alleviate the computing capacity shortage came online only near the end of the quarter, so related costs had a limited impact during the period; as usage increases in the fourth quarter, Bernstein expects margins to come under pressure.
Google Services operating margin was approximately 41%, declining for a second consecutive quarter; computing costs, the accelerated rollout of Gemini 4 and higher headcount all added pressure. Company-wide operating margin fell from 34.0% in the second quarter to 31.8%.
Third-quarter earnings per share were $2.12, below market consensus of $2.99; operating profit below expectations and a $8.7 billion loss on equity securities were the main reasons.
How do capital expenditure and cash flow change the valuation?
Third-quarter capital expenditure was $51.4 billion, below Bernstein’s estimate of approximately $57.7 billion; the company maintained its full-year 2026 capital expenditure guidance and its expectation of a significant increase in investment in 2027. Bernstein believes the quarterly shortfall was more likely related to the timing of computing equipment deliveries.
Third-quarter free cash flow was negative $9.1 billion, affected by capital expenditure, inventory investment related to TPU system sales and payment of an EU fine; cash and marketable securities at quarter-end were approximately $265 billion. Bernstein expects full-year free cash flow of approximately negative $19.6 billion in 2026 and negative $61.7 billion in 2027.
Bernstein raised its cloud revenue forecasts, lowered its search forecasts and cut its 2026 and 2027 earnings-per-share estimates because of lower margins and slowing search growth. The firm reduced its price target from $385 to $325 and maintained its Market Perform rating; it lowered its 2027 forward EV/EBIT valuation multiple from 24 times to 18 times, citing factors including slower search growth and a revenue mix shifting toward cloud and hardware.
