Google’s Q2 cloud business beats expectations again, but negative free cash flow triggers a valuation reassessment

Alphabet reports 2026 Q2 results: revenue, cloud computing, and advertising overall beat expectations, with Google Cloud growth again exceeding the most optimistic forecasts from buyers; the company also raised its full-year capital expenditure guidance and expects to continue significantly increasing investment in 2027, supporting the AI chip, server, storage, and data center industry chain.

However, rapid growth in capital expenditures pushed free cash flow into negative territory, and EPS excluding investment gains also fell short of expectations. Management acknowledged that Gemini still needs improvement in coding ability, but has not yet provided a clear catch-up timeline or verifiable quantified targets. The backlog orders in the cloud business continued to grow, but the quarter-over-quarter growth rate slowed markedly. Alphabet’s share price fell about 3% after hours.

Q2 results: revenue beat expectations, core EPS slightly below expectations

Q2 revenue was $119.8 billion, up 24% year over year, exceeding the consensus estimate of $116.96 billion.

Net profit rose 297.6% year over year to $112.1 billion, and EPS was $9.11. Among this, unrealized net gains driven by equity investment valuation increases contributed $77.1 billion to net profit; after excluding other income, EPS was about $2.85, below the consensus estimate of $2.95.

Therefore, the sharp increase in net profit and GAAP EPS was mainly driven by investment income, while core business performance is more appropriately judged by operating profit, cloud business growth, and cash flow.

Cloud business surpassed the most optimistic expectations, but backlog growth slowed

Google Cloud revenue was $24.77 billion, up 81.8% year over year, accelerating further from 63.4% in Q1, significantly above the consensus estimate of 64.3% and the buyers’ optimistic forecast of 75%.

Cloud backlog orders grew 11.7% quarter over quarter to $51.40 billion, adding about $514B in a single quarter, mainly driven by enterprise AI product demand and TPU orders. More than half are expected to be recognized as revenue within the next 24 months. However, incremental backlog growth has clearly slowed versus the earlier period. Whether Cloud can maintain the current growth rate going forward will still depend on the scale of new contracts, the speed of compute delivery, and the timing of TPU revenue recognition.

Gemini Enterprise has become an important growth driver for Cloud, with nearly 90% of Fortune 100 companies using it. The number of model calls processed via APIs by customers rose to over 22 billion Tokens per minute, up from 16 billion in the previous quarter, a 37.5% increase, showing that enterprise AI demand is still expanding rapidly.

Advertising business overall met expectations:

Total advertising revenue was $81.63 billion, up 14.4% year over year, slightly above market expectations of $81.1 billion.

Search revenue was $63.27 billion, up 16.8% year over year, basically in line with the $63.3 billion market expectation, but growth was lower than Q1’s 19.1%.

YouTube advertising revenue was $11.06 billion, up 12.9% year over year, above the $10.8 billion expected.

Google Network revenue was $7.3 billion, down 0.7% year over year, still slightly above the $7.13 billion expectation.

Capex raised again, free cash flow turned negative

Q2 capital expenditures reached $44.92 billion, up 100.5% year over year and up 25.9% quarter over quarter. The company raised its 2026 capital expenditure guidance from $180 billion–$190 billion to $195 billion–$205 billion; both the upper and lower bounds increased by $15 billion. It also expects 2027 capital expenditures to continue to grow significantly.

The ongoing increases in investment reflect that Google Cloud, Gemini training, and TPU demand are still constrained by compute supply, providing medium- to long-term support for AI accelerators, storage, servers, optical communications, and data center buildouts.

The cost has already shown up in cash flow. Q2 free cash flow fell from $10.12 billion in the prior quarter to negative $5.86 billion, and capital expenditures exceeded operating cash flow for the first time. As depreciation, energy, and data center operating costs are gradually reflected in the income statement, the market’s valuation of Alphabet will rely even more on how quickly revenue from AI investments translates into results and on the return on capital.

Earnings call: compute tightness continues, Gemini 4 still needs to prove competitiveness

Management said the company still faces a severe shortage of compute. For Q3, it will temporarily expand third-party compute rentals to avoid losing large customers in the short term due to insufficient capacity. Third-party compute costs are higher and are expected to put some pressure on Cloud profit margins, but will help preserve the value of long-term contracts.

For the first time this quarter, Google delivered TPU systems to customers and recognized revenue. In 2026, it will recognize only a small amount of revenue; the vast majority of existing TPU contract revenue will be recognized in 2027. By expanding TPU sales from internal infrastructure to external systems, Google Cloud increases its potential market and also improves visibility into demand for advanced upstream processes, HBM, servers, and networking equipment.

On the model side, Google has started the largest-scale pretraining for Gemini 4, hoping to regain leadership in the next-generation frontier models. Management also acknowledged that the current Gemini 4 still needs improvements in coding and agentic programming capabilities. Because Gemini 4 has not yet disclosed a clear release timeline, performance metrics, or a commercialization path, the earnings call was unable to fully ease market concerns about the competitiveness of Google’s models.

This earnings report shows that enterprise AI demand remains strong, and Google Cloud is accelerating the monetization of AI investment. The after-hours decline reflects that the market’s evaluation criteria have risen further: while cloud revenue beating expectations is a positive, negative free cash flow, continuously expanding capital expenditures, and uncertainty around Gemini’s frontier capabilities will jointly determine the valuation upside for Alphabet in its next phase.