Performance exceeds expectations + explosive growth in cloud business, why is Google still falling?

Google’s parent company Alphabet delivered an impressive second-quarter report card, with cloud business growth far exceeding expectations and both overall revenue and earnings per share beating Wall Street forecasts by a wide margin. However, the stock price still plunged, reflecting deep concerns in the market about sharply rising capital expenditures, negative free cash flow, and issues such as equity dilution.

According to a Bank of America Securities report, Alphabet’s net revenue in the second quarter reached $103.6 billion, higher than the market expectation of $101.1 billion. Google Cloud revenue grew 82% year-over-year, far beyond the market’s forecast of 65%, with particularly strong momentum.

Meanwhile, the company raised its fiscal 2026 capital expenditure guidance by $15 billion to a range of $195–$205 billion, up significantly from the previous guidance of $180–$190 billion. This news became the key factor weighing down the stock price.

Bank of America Securities analyst Justin Post maintained a “Buy” rating for Alphabet in the report with a target price of $430. He pointed out that despite the negative market reaction to increased capital expenditure, the backlog of cloud business orders, customer overspending, and continued expansion of cloud profit margins all indicate that incremental investment is directly translating into revenue growth.

In U.S. premarket trading, Google shares dropped nearly 5%.

Explosive growth in the cloud business—a major highlight this quarter

Google’s cloud business achieved remarkable accelerated growth this quarter, catching the market’s attention.

Second-quarter cloud revenue reached $24.8 billion, up 82% year-over-year—not only far exceeding the market expectation of 65%, but also 19 percentage points higher than first quarter's 63% growth. Operating margin in the cloud business rose to 35.6%, above the expected 31.3%. It increased by 270 basis points compared to last quarter and nearly 15 percentage points year-over-year.

The Bank of America Securities report indicated several data points underpin the sustainability behind the strong performance of the cloud business: second-quarter cloud order backlog grew 11% quarter-on-quarter and about 375% year-over-year to $514 billion; the ratio of customers’ actual consumption exceeding contractual commitments exceeded 50%, higher than 45% in Q1; the speed of acquiring new customers was more than double that of the same period last year.

Additionally, this quarter included new revenue from sales of TPU chips to external customers. Management stated that even excluding TPU sales, cloud business growth would still “accelerate significantly.”

Google’s model API currently processes about 22 billion tokens per minute, a significant increase from 16 billion last quarter. The weekly active user count for the AI agent development platform AntiGravity has exceeded 2.4 million. Bank of America Securities expects Google Cloud’s revenue growth to accelerate further to 93% in Q3.

Search and Overall Performance: Beating expectations but highlights are uneven

Overall, Alphabet’s GAAP earnings per share for the second quarter were $9.11, far surpassing the market forecast of $2.90, but note this includes about $98 billion in other income, mainly from revaluation gains in Anthropic, while the market previously expected only $0.8 billion. Excluding this one-off factor, the core business performance is more indicative.

Search business revenue was $63.3 billion, rising 17% year-over-year, roughly matching market expectations. It underperformed compared to last quarter’s stronger results and was seen by the market as a phase of “cooling” for recent AI-driven growth logic.

Management also warned that the search business would face tougher year-over-year comparison pressure in Q3.

YouTube ad revenue was $11.1 billion, up 13% year-over-year, beating market expectations of $10.8 billion, partly benefiting from brand ad demand spurred by the FIFA World Cup. Operating margin: GAAP operating margin for Q2 was 39.3%, below market expectation of 40.3%, mainly dragged down by G&A overspending—actual G&A expenses of $6.46 billion, well above the expected $5.1 billion. Management attributed this to certain legal and other matters, but gave no details.

Surging capital expenditure and negative free cash flow: the market's biggest concern

The market’s negative reaction to this quarter’s results is centered on the sharp rise in capital expenditures and its impact on cash flow.

Alphabet raised its fiscal 2026 capex guidance to $195–$205 billion, about 8% higher than previous guidance and considerably above market expectations of $187 billion. Bank of America Securities estimates full-year free cash flow for 2026 will be negative $16 billion, and also negative in 2027.

Meanwhile, Alphabet did not conduct any stock buybacks this quarter, with free cash flow at negative $5.9 billion. After completing $45 billion in mixed capital financing in June, the company plans to launch a $40 billion at-the-market (ATM) share issuance program in Q3. Bank of America expects this will dilute share capital by about 1% in the second half.

Bank of America Securities analyst Justin Post pointed out that although these factors create short-term pressure, the increase in capital expenditures is directly linked to the rapid growth in cloud business backlog—backlog orders totaling $514 billion far exceed the $15 billion increase in capex, meaning the logic of “more capacity equals more sales” still holds. He maintains his 2026 capex forecast at around $200 billion and raises his 2027 capex forecast to about $300 billion, an increase of about 51% year-over-year.

Valuation and Rating: Current price remains attractive

Bank of America Securities maintains a “Buy” rating on Alphabet with a $430 target price, based on 2027 adjusted GAAP EPS of $15.55 times a PE of 27, plus $11 per share in cash.

The report raises the 2026 net revenue forecast by 2% to $433.6 billion and EPS by 4% to $20.58; 2027 net revenue up 3% to $552.8 billion and EPS up 2% to $15.01.

At an after-hours price level of about $332, Alphabet’s PE ratio on 2027 GAAP EPS is about 22 times, matching the company’s 10-year historical average, but Bank of America expects revenue growth in 2027 to reach 27%, far above the 14% average for 2023–2025.

From a segment valuation perspective, removing assets like YouTube, cloud business, Waymo, and cash, Google’s core advertising and Play business has an implied valuation of only 13 times expected 2026 earnings, lower than the S&P 500 Index’s 20 times.

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