Alphabet stock drops 15% amid concerns over AI search and spending

Such growth would be considered outstanding for the vast majority of companies, but Wall Street still isn’t buying it.

Is AI going to disrupt Google's most profitable business?

In the third quarter, Alphabet reported revenue of $127.58 billion, below Wall Street’s expectation of $128.2 billion. GAAP earnings per share were $2.12, while adjusted earnings per share, excluding certain investment gains and losses, were approximately $2.67, still below the market expectation of $3.02.

However, the lower-than-expected profit was due to special circumstances: a decline in the value of Google's equity stake in SpaceX resulted in an approximately $8.7 billion unrealized loss on securities investments during the quarter—this was not direct operating losses.

In fact, Alphabet's operating profit still increased by 30% year-over-year to $40.6 billion.

What unsettles investors is the sudden slowdown in search advertising growth.

Google Search's third-quarter revenue was $63.35 billion, a 12% year-over-year increase, compared to a 17% growth rate in the previous quarter. Wall Street had expected search revenue to approach $65 billion.

A 12% growth doesn't sound bad, but search advertising has long been Google's most important source of profit. Investors have historically been willing to assign Google a higher valuation because they believed the search business would continue to grow and deliver stable cash flow.

Today, this assumption is beginning to be challenged.

Bank of America analysts Justin Post and Nitin Bansal noted in their report on October 29 that weaker-than-expected search revenue may intensify market concerns about AI search diversion, shifting ad budgets, and competition from AI agents. They believe search growth may continue to face pressure until at least the first quarter of 2027.

There is a notable contradiction in this earnings report. Google CEO Sundar Pichai stated that the year-over-year growth rate of search queries reached its highest level in five years. This means that the number of people using Google Search and the volume of search activity have not suddenly declined; rather, they have become more active.

But why has the revenue growth slowed down?

The answer may lie in AI search itself.

In the past, when users searched for “best hotels in New York,” Google displayed a series of web links and paid advertisements. Hotels and travel platforms were willing to pay Google for advertising to attract user clicks.

Now, users may directly ask an AI agent or various models: “Help me find a hotel in New York with convenient transportation and a rate of under $200 per night.”

AI can directly provide organized answers and even complete bookings further. Users may not need to click on traditional ads.

This means that the search experience may be better, but the advertising revenue generated per search may decrease.

On the October 28 earnings call, Google's Chief Business Officer Philipp Schindler explicitly acknowledged that the current monetization level of AI Mode is lower than that of traditional search and has already impacted search revenue growth.

So, is search really going to be replaced by AI? Not even close, not yet.

According to Statcounter data, in September 2026, Google's share of the global traditional search engine market remained close to 90%. Moreover, Google itself offers products such as Gemini, AI Overviews, and AI Mode.

The real threat to Google is not necessarily that users will stop using it, but that the way users engage with Google has changed, and Google may no longer be able to profit in the same way as before.

Furthermore, if AI assistants like ChatGPT and Claude can eventually perform searches, shopping, booking tickets, and payments directly, advertisers may no longer need to acquire customers through traditional search results.

This is the long-term risk faced by search business models.

A greater concern is that AI investments are becoming increasingly expensive.

If the search advertising slowdown were merely a deceleration, Google might not have faced such a sharp sell-off.

Another key factor is cash flow.

Google expects its capital expenditures to reach $195 billion to $205 billion in 2026 and has indicated that spending will increase significantly in 2027. The company also disclosed future purchase commitments of $924 billion and uninitiated leases and other related obligations of $152 billion, totaling over $1 trillion.

It’s important to emphasize that these represent the largest contractual obligations over many years, not a requirement for Google to pay $1 trillion next year—but they reflect a reality: AI has become an extremely costly infrastructure race.

Reuters, citing Jeremy Saltsburg, an analyst at Check Capital, noted that if Google's future capital expenditures reach $300 billion, the market could become even tighter, as the company's free cash flow has already turned negative.

The issue is not that Google lacks money to invest, but rather how much return these investments will generate in the future.

Cloud business doubles, but why can't it save the stock price?

This earnings report also has some good news.

Google Cloud's third-quarter revenue was $30.7 billion, a 103% year-over-year increase; operating profit reached $11.1 billion. The backlog of cloud business orders amounted to $561 billion, with over 55% expected to be converted into revenue within the next 24 months.

Meanwhile, Google is expanding the availability of its custom TPU AI chips to more external customers and partnering with companies such as Oracle.

This means Google is no longer just using AI chips to run its own services, but is beginning to generate revenue by selling AI computing systems.

From a growth perspective, this is an exciting new business.

But Wall Street has different concerns.

First, building cloud computing infrastructure requires continuous substantial financial investment. Second, selling TPU systems may involve high hardware costs, inventory commitments, and extended revenue recognition cycles.

Google's management also acknowledged that using third-party computing resources will put pressure on the near-term profitability of its cloud business.

Citizens analyst Andrew Boone noted that while he is bullish on the cloud business, search remains Google’s more valuable business, as cloud computing requires higher capital investment and some TPU hardware sales lack the inherent sustainability of the advertising business.

Analyst View

After the earnings report, multiple investment banks lowered their target prices for Google.

JPMorgan analyst Doug Anmuth lowered the target price from $425 to $375, while maintaining an overweight rating. He believes that the headwinds facing the search business may be more easily resolved and not necessarily a permanent structural decline.

Bank of America lowered its price target from $430 to $380, maintained a buy rating, but became more cautious about search growth over the next few quarters.

UBS lowered its price target from $380 to $332 and maintained a neutral rating. Analyst Stephen Ju is particularly focused on the pace of monetization of AI search.

Citizens is relatively pessimistic, with analyst Andrew Boone downgrading Alphabet from “Outperform” to “Market Perform.” He believes that as AI agents may become the new internet gateway, Google faces significant risks in its commercialization transformation.

Analysts generally believe that over the next few quarters, three metrics impacting Google's valuation are worth watching:

First, can search advertising revenue accelerate again? Google has expanded AI Mode ads to overseas markets and is testing multi-turn dialogue ads in the U.S. If these new formats can boost revenue without harming user experience, it would demonstrate that AI is creating new advertising markets rather than cannibalizing search business.

Second, when will free cash flow stabilize? Google will continue investing in the short term, but the market needs to see capital expenditure growth slow down, or operating cash flow growth sufficient to cover new investments. The 2027 capital expenditure guidance is an important indicator to watch.

Third, can the cloud business turn orders into high-quality profits? A $561 billion order backlog indicates strong demand, but it does not mean the money is already in hand. Future focus should be on TPU revenue, cloud business profit margins, and whether orders will be fulfilled as expected. Additionally, Google must navigate long-term uncertainties such as competition from AI agents, changes in search advertising models, and antitrust regulations.

Author: bootly

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