Google’s Q2 cloud business beats expectations again, but negative free cash flow raises valuation concerns

Author: SosoValue

Alphabet releases 2026 Q2 results: revenue, cloud computing, and advertising business overall beat expectations, and Google Cloud’s growth rate again exceeded the most optimistic forecast 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, the rapid growth in capital expenditures pushed free cash flow into negative territory, and EPS excluding investment gains also came in below expectations. Management admits Gemini still needs to improve in coding ability, but has not yet provided a clear catch-up timeline or verifiable quantitative targets. The backlog orders in the cloud business continue to grow, but the quarter-over-quarter growth rate has clearly slowed. Alphabet’s stock fell by about 3% after-hours.

Q2 results: revenue beat expectations, core EPS slightly below

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

Net profit grew 297.6% year over year to $112.1 billion, with EPS of $9.11. Of this, $77.1 billion of unrealized net gains driven by equity investment valuation increases contributed to net profit. Excluding other gains, EPS was about $2.85, below the consensus estimate of $2.95.

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

Cloud business beats the most optimistic expectations; backlog growth rate slows

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

Cloud backlog orders grew 11.7% quarter over quarter to $514 billion, adding about $54 billion in a single quarter. It was mainly driven by demand for enterprise AI products and TPU orders, and more than half is expected to be recognized as revenue within the next 24 months. However, the incremental growth in backlog has clearly slowed versus the earlier period. Whether Cloud can maintain the current growth rate in the future still depends on the size of new contract deals, the pace of compute capacity 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 by customers via API rose to more than 22 billion tokens per minute, up 37.5% from 16 billion in the prior quarter, showing that enterprise AI demand is still expanding rapidly.

Advertising business overall matched expectations:

● Total ad revenue was $81.63 billion, up 14.4% year over year, slightly above the market expectation 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 below Q1’s 19.1%.

● YouTube ad revenue was $11.06 billion, up 12.9% year over year, above the $10.8 billion expectation.

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

Capex raised again; free cash flow turns 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 capex guidance from $180 billion–$190 billion to $195 billion–$205 billion, with both the upper and lower bounds increasing by $15 billion, and expects 2027 capex to continue to grow significantly.

The continuously increased spending reflects that Google Cloud, Gemini training, and TPU demand are still constrained by compute capacity supply, providing long-term support for demand related to AI accelerators, storage, servers, optical communications, and data center construction.

The cost is already reflected in cash flow. Q2 free cash flow fell from $10.12 billion in the prior quarter to negative $5.86 billion; capex exceeded operating cash flow for the first time. As depreciation, energy, and data center operating costs are gradually included in the income statement, the market’s valuation of Alphabet will rely more heavily on the speed at which revenue from AI investment is converted, and the return on capital.

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

Management said the company still faces a severe lack of compute capacity. In Q3, it will temporarily expand third-party compute rental to avoid losing large customers due to near-term capacity shortages. Third-party compute costs are higher and are expected to put some pressure on Cloud profit margins, but it helps preserve the value of long-term contracts.

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

On models, Google has launched Gemini 4’s largest-scale pretraining, hoping to regain a leading position for next-generation frontier models. Management also acknowledged that current coding and agent programming capabilities of the model still need improvement. Because Gemini 4 has not yet announced a clear release timeline, performance data, or commercialization path, the earnings call could not fully alleviate 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 realization of AI investment. The after-hours decline reflects that the market’s evaluation criteria have been raised again: Cloud revenue beating expectations is still a positive, but negative free cash flow, continuously expanding capital expenditures, and uncertainty around Gemini’s frontier capabilities will jointly determine Alphabet’s valuation headroom in the next stage.