Author: Zhui Feng Trading Desk
Alphabet, Google's parent company, delivered a stellar second-quarter report card, with cloud business growth far exceeding expectations, and overall revenue and earnings per share significantly beating Wall Street estimates. However, the stock still plunged, reflecting market concerns over deeper underlying issues such as a sharp spike in capital expenditures, negative free cash flow, and equity dilution.
According to a Bank of America Securities research report, Alphabet's Q2 net revenue reached $103.6 billion, higher than the market expectation of $101.1 billion. Google Cloud revenue grew 82% year-over-year, far surpassing the market expectation of 65%, with the acceleration being particularly notable.
Simultaneously, the company raised its fiscal year 2026 capital expenditure guidance by $15 billion to a range of $195 billion to $205 billion, a significant increase from the previous guidance of $180 billion to $190 billion. This news became the core variable suppressing the stock price.
Bank of America Securities analyst Justin Post maintained a "Buy" rating on Alphabet with a price target of $430 in the report. He pointed out that despite the negative market reaction to the raised capex guidance, the backlog of cloud business, customer overconsumption, and the continued expansion of cloud profit margins all indicate that incremental investments are directly translating into revenue growth.
In pre-market trading, Google's decline widened to nearly 5%.
Explosive Growth in Cloud Business, the Biggest Highlight of the Quarter
Google's cloud business achieved impressive accelerated growth this quarter.
Second-quarter cloud revenue reached $24.8 billion, an 82% year-over-year increase, not only significantly exceeding the market expectation of 65% but also accelerating by 19 percentage points compared to Q1's 63% growth. The cloud business operating margin rose to 35.6%, also higher than the market expectation of 31.3%, up 270 basis points from the previous quarter and nearly 15 percentage points from a year ago.
The Bank of America Securities report points out that behind the cloud business's strong performance, multiple data points support its sustainability: Cloud business backlog grew 11% sequentially and approximately 375% year-over-year in Q2, reaching $514 billion; actual customer spending exceeded contractual commitments by over 50%, higher than Q1's 45%; the rate of new customer acquisition is more than double that of the same period last year.
Furthermore, this quarter included new revenue from selling TPU chips to external customers. Management stated that even excluding TPU sales, cloud business growth would still be "significantly accelerating."
Google's model APIs currently process about 22 billion tokens per minute, a significant increase from last quarter's 16 billion; the weekly active users of the AI agent development platform AntiGravity have exceeded 2.4 million. Bank of America Securities expects Google Cloud revenue growth to further accelerate to 93% in Q3.
Search and Overall Performance: Exceeding Expectations but Highlights Uneven
Overall, Alphabet's Q2 GAAP earnings per share were $9.11, significantly beating the market expectation of $2.90. However, note that this included about $98 billion in other income, primarily from revaluation gains on Anthropic, whereas the market had previously expected this item to be only $0.8 billion. Excluding this one-time factor, the core business performance is more genuine.
Search revenue was $63.3 billion, a 17% year-over-year increase, roughly in line with market expectations but slightly weaker than the previous quarter's strong beat, seen by the market as a temporary "cooling" signal for the recent AI uptrend narrative.
Management also indicated that search business will face higher year-over-year comparables in Q3.
YouTube ad revenue was $11.1 billion, up 13% year-over-year, exceeding the market expectation of $10.8 billion, partially benefiting from brand advertising demand driven by the FIFA World Cup. Regarding operating margin, the Q2 GAAP operating margin was 39.3%, below the market expectation of 40.3%, mainly dragged down by G&A expense overruns—actual G&A spending was $6.46 billion, far above the market expectation of $5.1 billion. Management attributed this to several legal and other matters but did not provide detailed disclosure.
Soaring Capital Expenditures and Negative Free Cash Flow, the Market's Biggest Worry
The negative market reaction to this quarter's earnings stems from the core conflict surrounding the significant increase in capital expenditures and its impact on cash flow.
Alphabet raised its fiscal year 2026 capital expenditure guidance to $195 billion to $205 billion, an increase of about 8% from previous guidance and significantly higher than the market expectation of $187 billion. Bank of America Securities expects full-year 2026 free cash flow to be negative $16 billion, also negative in 2027.
Meanwhile, Alphabet did not conduct any share repurchases in Q2, and free cash flow was negative $5.9 billion. After completing a $45 billion hybrid capital financing in June this year, the company plans to launch a $40 billion at-the-market (ATM) equity offering in Q3. Bank of America Securities expects this will lead to an approximate 1% sequential increase in diluted shares outstanding in the second half of the year.
Bank of America Securities analyst Justin Post noted that while the above factors create short-term pressure, the increase in capital expenditures is directly linked to the rapid growth of the cloud business backlog—the $514 billion backlog size far exceeds the $15 billion incremental capital expenditure, meaning the logic of "more capacity equals more sales" still holds. He maintains his forecast for ~$200 billion in 2026 capital expenditures and raises his 2027 capital expenditure forecast to ~$300 billion, a ~51% year-over-year increase.
Valuation and Rating: Current Price Still Attractive
Bank of America Securities maintains its "Buy" rating on Alphabet and its $430 price target, based on a 27x P/E multiple applied to its 2027 adjusted GAAP EPS of $15.55, plus $11 per share in cash.
The report raises its 2026 net revenue forecast by 2% to $433.6 billion and EPS by 4% to $20.58; raises its 2027 net revenue forecast by 3% to $552.8 billion and EPS by 2% to $15.01.
At the after-hours price level of around $332, Alphabet trades at about 22x its 2027 GAAP EPS, in line with the company's 10-year historical average. However, Bank of America Securities expects 2027 revenue growth to be 27%, far above the average of 14% from 2023-2025.
From a sum-of-the-parts valuation perspective, after excluding assets like YouTube, the cloud business, Waymo, and cash, the implied valuation for Google's core ads and Play business is only 13x expected 2026 earnings, below the S&P 500's 20x.
