Alphabet: the AI capex bill lands before the AI revenue
We initiate Alphabet at Hold with a $340 target, a 5.1% total return from $324.22. Our FY27E EPS of $12.54 is 17% below consensus of $15.123 (source: Yahoo Finance prices, consensus, targets and peer multiples (22 October 2026)) because $200bn of 2026 capex takes depreciation from $21bn to $75bn by FY28E and leaves free cash flow negative for two years.
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Key takeaways
- Search is compounding through the AI transition: Search & other grew 17% in 2Q26, with paid clicks +6% and cost-per-click +7% in FY251 (source: Alphabet Form 10-K for FY2025 (filed 5 February 2026)).
- Cloud revenue grew 82% in 2Q26 with a $514bn backlog and a 35.6% margin2 (source: Alphabet 2Q26 earnings call (22 July 2026)), but we expect the margin to peak at 33.5% in FY26E.
- Capex of $200bn in FY26E and $265bn in FY27E leaves free cash flow negative by $35bn and $58bn, and D&A rises from $21.1bn in FY25 to $75bn by FY28E.
- Our FY27E adjusted EPS of $12.54 is 17% below consensus of $15.123 (source: Yahoo Finance prices, consensus, targets and peer multiples (22 October 2026)), mostly because we model D&A of $55bn against consensus $38bn.
- We initiate at Hold with a $340 target, 27.1x FY27E adjusted EPS, for a 5.1% total return; bull case $420, bear case $200.
Investment thesis
Demand is not in doubt: Search grew 17% in 2Q26 and Cloud 82% on a $514bn backlog. The question is what the demand costs. Capex of $200bn in FY26E and $265bn in FY27E takes D&A from $21.1bn to $75bn by FY28E and keeps free cash flow negative for two years, and consensus is not modelling the depreciation. On operating EPS the stock trades at 25.9x FY27E against a 21.0x five-year average, so the re-rating is in the price. The bear case is not a broken business, so we rate Hold rather than Sell.
Valuation
The target blends 27.1x FY27E adjusted EPS of $12.54 ($340, 50% weight), a DCF at 8.3% WACC and 3.0% terminal growth ($331, 30%) and 16.5x FY27E EBITDA of $245.3bn ($341, 20%); the $337 blend is set at $340. Bull $420 is 27.1x FY27E EPS of $15.50 and bear $200 is 19.2x EPS of $10.40. At 25/50/25 probabilities the weighted value is $325, with a 0.77x upside-to-downside ratio.
Our estimates
| Line | FY26E | FY27E | FY28E |
|---|---|---|---|
| Revenue | $497.7bn | $598.5bn | $711.3bn |
| Consensus | $500.1bn | $626.8bn | — |
| Ours vs consensus | −0.5% | −4.5% | — |
| EPS | $11.14 | $12.54 | $14.75 |
| Consensus | $11.87 | $15.12 | — |
| Ours vs consensus | −6.1% | −17.1% | — |
Risks to our view
- Capex without return: D&A reaches 10.5% of sales by FY28E and a 100bp Cloud margin miss costs $2.60 a share; -$124 a share.
- Search displacement: AI answers cut monetised clicks and Search growth falls below 8% with paid clicks negative; -$60 a share.
- Multiple de-rating: a 10% Nasdaq drawdown costs about 12% on the 1.22 beta before any news; -$42 a share.
- Regulatory remedy: EU DMA and US default-search rulings remove distribution, putting 3-8% of Search revenue at risk; -$35 a share.
- Upside risk: external TPU system sales pass $45bn by FY28E; +$96 a share.
Sources
- 1Alphabet Form 10-K for FY2025 (filed 5 February 2026)
- 2Alphabet 2Q26 earnings call (22 July 2026)“significantly higher”
- 3Yahoo Finance prices, consensus, targets and peer multiples (22 October 2026)
- 4Alphabet quarterly 8-K and 10-Q filings, 1Q25 to 2Q26
- 5Alphabet Form 8-K for 4Q25 results (filed 4 February 2026)
- 6Signals financial statements and KPI series (retrieved 23 October 2026)
- 7Yahoo Finance holder data, 13F filings to 30 June 2026
- 8Alphabet 2025 proxy statement