Major Wall Street investment banks widely believe Alphabet's newly announced "explosive" capital expenditure plan will significantly pressure its near-term profit structure and free cash flow. Market focus has shifted from revenue growth to the sustainability of capital returns.
According to analysis, Morgan Stanley noted that Alphabet's parent company reported strong quarterly results, with both revenue and profit exceeding expectations. However, the company simultaneously announced a 2026 capital expenditure guidance of $175-185 billion, nearly double prior market expectations and equivalent to over 30% of the total data center capital expenditure of major global tech giants in 2023. This aggressive expansion plan immediately sparked deep investor concern regarding profit sustainability.
Although search business regained vitality, cloud business maintained high growth with significantly improved margins—providing a financial foundation for strategic investment—the massive capital expenditure has begun to compress profit margins. Morgan Stanley estimates that free cash flow per share will plummet by approximately 58% and 80% in fiscal years 2026 and 2027, respectively.
The core divergence lies in whether the market is willing to pay for this "long-term check" while AI investment returns remain uncertain, and whether capital expenditure on this scale can ultimately translate into substantial returns on capital. Alphabet is placing a major bet at a critical inflection point, redefining its growth trajectory and financial balance.
AI-Driven Acceleration in Core Businesses Alphabet delivered strong Q4 2023 results, with total revenue reaching $113.8 billion, representing 17% year-over-year growth on a constant currency basis, approximately 2 percentage points above market expectations. Growth was primarily driven by a dual-engine performance from Search and Cloud businesses.
Search business demonstrated stronger-than-expected growth resilience, with revenue of $63.1 billion, up 15.6% year-over-year on a constant currency basis—the highest growth rate since Q2 2022. Notably, achieving this growth rate on a revenue base 35% larger than that period underscores its quality.
Growth momentum stemmed from comprehensive AI integration. AI-powered search queries doubled during the quarter, with average query length three times that of traditional searches, and nearly one-sixth utilizing non-text formats like voice or image. The company launched over 250 AI search feature updates in the quarter and plans to maintain a pace of roughly 100 updates per quarter.
Concurrently, the Gemini ecosystem showed accelerated expansion, with monthly active users increasing 15% quarter-over-quarter to 750 million, indicating deepening user engagement. Its API now processes 10 billion tokens per minute, significantly higher than industry peers, highlighting its technical adoption advantage within the developer ecosystem.
Cloud Business Sees Volume and Price Increases Google Cloud demonstrated stronger-than-expected growth momentum and profit quality this quarter. Cloud revenue reached $17.7 billion, up 47.8% year-over-year, accelerating from the previous quarter and beating market expectations by about 9 percentage points. More critically, its operating margin improved significantly by 6 percentage points quarter-over-quarter to 30.1%, substantially above the market's prior expectation of 22.7%, indicating strong scaling effects and pricing power.
Growth drivers showed structural deepening. The core Google Cloud Platform (GCP) grew faster than the overall cloud business, primarily benefiting from broad demand increases in infrastructure, cybersecurity, data analytics, and enterprise AI solutions. Notably, the number of billion-dollar deals signed in 2025 has already surpassed the total from the previous three years combined, and nearly 75% of existing cloud customers are using AI products, with these customers using 1.8 times more products on average than non-AI users, indicating AI-driven deepening of customer value.
Business visibility improved further. As of Q4, cloud backlog grew 55% quarter-over-quarter to approximately $240 billion, doubling year-over-year. Based on this, Morgan Stanley forecasts GCP growth of 71% and 51% in fiscal years 2026 and 2027, respectively.
Enterprise AI product commercialization is advancing rapidly. Gemini Enterprise, just four months after launch, has secured over 2,800 enterprise customers with 8 million paid seats. Customer interactions processed in Q4 grew 65% year-over-year to over 5 billion. Meanwhile, revenue from products built on generative AI models grew nearly 400% year-over-year, with the pace of growth continuing to accelerate.
Capital Expenditure Guidance Significantly Revised Upwards Alphabet's newly announced 2026 capital expenditure guidance significantly exceeded market expectations. The mid-point of its $175-185 billion investment plan represents approximately 97% growth compared to 2025 estimates, far above the prior consensus expectation of around $129 billion. This investment intensity leads among major global cloud service providers.
Notably, Morgan Stanley calculates this guidance amount exceeds 32% of the total data center expenditure of the world's six largest cloud providers in 2023. Compared to Meta's recently announced $135 billion investment plan, Alphabet's scale is even more prominent; Meta's plan is only about 4% lower than the total 2023 industry expenditure.
Management clearly stated that related capital will be focused on technical infrastructure, with approximately 60% allocated to server deployment and the remaining 40% to data center construction and network equipment upgrades. The core challenge currently is expanding capacity "fast enough" to meet "extraordinary demand growth."
Execution-wise, Q4 capital expenditure alone reached $27.9 billion, an increase of $3.9 billion from the previous quarter. Full-year 2025 capital expenditure totaled $91.5 billion, a significant jump from $52.5 billion in 2024, reflecting a systematic increase in investment intensity.
Free Cash Flow Under Pressure The aggressive capital expenditure plan is materially impacting Alphabet's cash flow structure. Morgan Stanley estimates free cash flow per share for fiscal years 2026 and 2027 will drop to $2.15 and $1.48, respectively, representing downward revisions of 58% and 80% from prior expectations. Although Q4 free cash flow remained strong at $24.6 billion, with a full-year total of $73.3 billion, Bernstein predicts annual free cash flow could contract to $14.4 billion and $26.4 billion in fiscal years 2026 and 2027, respectively, with corresponding free cash flow yields falling below 1%.
Concurrently, rising depreciation expenses will further squeeze profit margins. Management has repeatedly indicated that depreciation growth will accelerate noticeably starting in Q1 2026 and show "significant growth" throughout the year. Q4 depreciation expense reached $6 billion, up 8% quarter-over-quarter, reflecting the accelerating accounting impact of prior capital investments.
Despite this backdrop, the company maintained shareholder returns, but the scale shows signs of tilting towards strategic investment. Q4 stock repurchases were $5.5 billion, below historical levels for the period; dividend payments were $2.5 billion. This shift in allocation structure suggests the company is directing more cash resources towards long-term AI capability building.
Operating Margin Slightly Pressured Alphabet's Q4 operating profit was $35.9 billion, with an operating margin of 31.6%, slightly below market expectations. Excluding a one-time $2.1 billion employee compensation-related expense for Waymo, the adjusted operating margin was approximately 33%, still slightly narrower than the 34% average for the first three quarters.
By segment, the Google Services division's operating margin improved to 41.9%, expanding 280 basis points year-over-year. Google Cloud's profitability showed marked progress, with its operating margin reaching 30.1%, up 1,260 basis points year-over-year and 640 basis points quarter-over-quarter, demonstrating strong operating leverage.
Total operating expenses for the quarter grew 29% year-over-year to $32.1 billion. Research and development expenses increased 42%, primarily driven by compensation costs (especially related to Waymo) and higher depreciation. Sales and marketing expenses grew 12%, while general and administrative expenses increased 21%.
Regarding headcount, total employees increased by approximately 700 quarter-over-quarter, up 4% year-over-year. Management clearly stated intentions to continue selective hiring in strategic priority areas like AI and cloud infrastructure to support long-term technology investment and business expansion.
Divergent Institutional Ratings: Weighing Growth Momentum vs. Capital Expenditure Morgan Stanley maintained an "Overweight" rating on Alphabet. Its valuation is primarily based on 24 times estimated 2027 earnings per share, with a bull case scenario implying 28 times. The target price suggests limited upside potential, reflecting cautious market expectations regarding near-term profit pressure.
Citigroup reiterated a "Buy" rating and raised its valuation multiple, applying approximately 27 times estimated 2027 price-to-earnings. The firm believes the combination of Google Cloud's revenue reacceleration, strong demand for TPUs and Gemini, and the ongoing resilience of the search business supports a valuation premium for the company.
Bernstein maintained a "Market-Perform" rating. Its valuation framework combines an increased 2027 enterprise value-to-EBITDA multiple with a discounted cash flow model, assuming a weighted average cost of capital of 10% and a terminal growth rate of 3.5%, with equal weighting. This adjustment reflects the firm's recognition of the company's growth momentum while maintaining a relatively cautious stance on valuation upside.
Overall, while major banks generally raised revenue expectations for Alphabet's Search and Cloud businesses, earnings per share forecasts remained largely stable due to significant downward revisions in free cash flow expectations resulting from the heightened capital expenditure. Institutions are acknowledging the long-term growth logic while simultaneously digesting the structural pressure that high-intensity capital investment places on near-term profits and cash flow.
Market Turns Cautious Investors are showing growing caution towards tech giants' aggressive capital expenditure plans. In 2026, the combined capital expenditure of Meta, Alphabet, Microsoft, and Amazon is projected to climb into the $700-900 billion range. For this nearly trillion-dollar investment scale to yield substantial returns, the total addressable market for new AI-driven products and enhanced features must reach several times the investment amount in the short term, placing extremely high demands on the industry's commercialization capabilities.
Simultaneously, the competitive landscape is evolving rapidly. OpenAI's continued innovation presents a long-term challenge, while Meta, xAI, Anthropic, and Amazon are actively competing for enterprise and consumer user behavior with their own AI agent solutions. Each participant clearly aims to achieve returns on their investments, moving the industry competition into a new phase oriented towards commercial monetization.
Morgan Stanley analysis indicates that Alphabet's key challenge is consistent execution of its strategy and effectively monetizing its vast user base and data resources into products and services. While the firm believes Alphabet, with its ecosystem and technological assets, remains better positioned than most competitors—a strength demonstrated again in the latest earnings—the market clearly understands: all growth comes at a cost, and today's massive investments must translate into commensurate financial returns in the future.
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