Why is Google still falling despite exceeding performance expectations and a huge boom in cloud business?

Author: Wind Trading Desk

Google's parent company Alphabet has delivered an impressive second-quarter report, with cloud business growth far exceeding expectations, and overall revenue and earnings per share significantly beating Wall Street forecasts. However, the stock price still plummeted, reflecting market concerns about sharply rising capital expenditures, negative free cash flow, and equity dilution.

According to a report from Bank of America Securities, Alphabet's net revenue for the second quarter reached $103.6 billion, surpassing the market expectation of $101.1 billion. Google Cloud revenue grew by 82% year-over-year, far exceeding the market expectation of 65%, with particularly strong acceleration.

At the same time, the company raised its capital expenditure guidance for fiscal year 2026 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 has become a core variable suppressing the stock price.

Bank of America Securities analyst Justin Post maintained a "Buy" rating on Alphabet with a target price of $430. He pointed out that despite the capital expenditure increase triggering a negative market reaction, the backlog of cloud business orders, customer overspending, 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 stock fell nearly 5%.

Explosive Growth in Cloud Business Becomes the Highlight of the Season

Google's cloud business achieved notable accelerated growth this quarter.

Cloud revenue for the second quarter reached $24.8 billion, an 82% year-over-year increase, not only significantly surpassing the market expectation of 65% but also improving by 19 percentage points from the 63% growth in the first quarter. The operating profit margin for the cloud business rose to 35.6%, also exceeding the market expectation of 31.3%, an increase of 270 basis points from the previous quarter and nearly 15 percentage points from the same period last year.

The Bank of America Securities report pointed out that the strong performance of the cloud business is supported by multiple data points indicating its sustainability: the backlog of cloud business orders grew by 11% quarter-over-quarter and approximately 375% year-over-year, reaching $514 billion; the actual customer spending exceeded contractual commitments by over 50%, higher than the 45% in the first quarter; and the speed of acquiring new customers is more than double that of the same period last year.

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

The Google Model API currently processes about 22 billion tokens per minute, a significant increase from 16 billion in the previous quarter; the weekly active users of the AI agent development platform AntiGravity have exceeded 2.4 million. Bank of America Securities expects that the growth rate of Google Cloud revenue in the third quarter will further accelerate to 93%.

Search and Overall Performance: Exceeding Expectations but Uneven Highlights

Overall, Alphabet's second-quarter GAAP earnings per share were $9.11, significantly exceeding the market expectation of $2.90. However, it is important to note that this includes approximately $98 billion in other income, mainly from the revaluation gains on Anthropic, while the market had previously expected this item to be only $800 million. Excluding this one-time factor, the core business performance is more reflective.

Search business revenue was $63.3 billion, a 17% year-over-year increase, which was basically in line with market expectations but fell short compared to the previous quarter's better-than-expected performance, seen by the market as a temporary "cooling" signal for the recent AI uptrend.

Management also indicated that the search business will face higher year-over-year baseline pressure in the third quarter.

YouTube ad revenue was $11.1 billion, a 13% year-over-year increase, exceeding the market expectation of $10.8 billion, partly benefiting from brand advertising demand generated by the FIFA World Cup. In terms of operating profit margin, the second quarter GAAP operating profit margin was 39.3%, lower than the market expectation of 40.3%, mainly dragged down by overspending on G&A expenses—actual G&A spending was $6.46 billion, far exceeding the market expectation of $5.1 billion, which management attributed to several legal and other matters but did not disclose in detail.

Surge in Capital Expenditures and Negative Free Cash Flow: The Market's Biggest Concern

The market's negative reaction to this quarter's performance centers on the significant increase in capital expenditures and its impact on cash flow.

Alphabet raised its capital expenditure guidance for fiscal year 2026 to $195 billion to $205 billion, an increase of about 8% from the previous guidance, and significantly higher than the market expectation of $187 billion. Bank of America Securities expects that the free cash flow for the entire year of 2026 will be negative $16 billion, and similarly negative in 2027.

At the same time, Alphabet did not conduct any stock buybacks in the second quarter, with free cash flow being negative $5.9 billion. After completing a $45 billion mixed capital financing in June this year, the company plans to launch a $40 billion at-the-market (ATM) equity issuance in the third quarter. Bank of America Securities expects this will lead to a year-over-year increase in diluted shares of about 1% in the second half of the year.

Bank of America Securities analyst Justin Post pointed out that although the above factors create short-term pressure, the increase in capital expenditures is directly linked to the rapid growth of cloud business backlog—$514 billion in backlog far exceeds the $15 billion increase in capital expenditures, which means that the logic of "more capacity equals more sales" still holds. He maintains a forecast of about $200 billion in capital expenditures for 2026 and raises the 2027 capital expenditure forecast to about $300 billion, a year-over-year increase of about 51%.

Valuation and Rating: Current Price Still Attractive

Bank of America Securities maintains a "Buy" rating on Alphabet with a target price of $430, based on a 2027 adjusted GAAP earnings per share of $15.55 multiplied by a 27 times price-to-earnings ratio, plus $11 in cash per share.

The report raised the 2026 net revenue forecast by 2% to $433.6 billion and increased the earnings per share forecast by 4% to $20.58; the 2027 net revenue forecast was raised by 3% to $552.8 billion, and the earnings per share forecast was raised by 2% to $15.01.

At an after-hours price level of about $332, Alphabet's price-to-earnings ratio corresponding to the 2027 GAAP earnings per share is about 22 times, in line with the company's 10-year historical average, but Bank of America Securities expects the revenue growth rate for 2027 to reach 27%, far exceeding the average level of 14% from 2023 to 2025.

From a segment valuation perspective, excluding assets such as YouTube, cloud business, Waymo, and cash, the implied valuation of Google's core advertising and Play business is only 13 times the expected earnings for 2026, lower than the 20 times of the S&P 500 index.