Bank of America believes that the biggest highlight of the second-quarter earnings report was Google Cloud's revenue, which surged 82% year-over-year, far exceeding expectations. The cloud business's backlog hit a record high, as AI investments are accelerating revenue realization. Although a significant upward revision in capital expenditures weighed on the stock price, BofA maintains a "Buy" rating, asserting that the long-term thesis remains intact.
Google's parent company Alphabet delivered an impressive second-quarter report, with cloud business growth far exceeding expectations, and both overall revenue and earnings per share significantly beating Wall Street forecasts. However, the stock still tumbled, reflecting deep-seated market concerns over surging capital expenditures, negative free cash flow, and equity dilution.
According to a BofA Securities report, Alphabet's second-quarter net revenue reached $103.6 billion, surpassing the market consensus of $101.1 billion. Google Cloud revenue surged 82% year-over-year, well above the expected 65%, with an especially pronounced acceleration.
Meanwhile, the company raised its fiscal 2026 capital expenditure guidance by $15 billion to a range of $195 billion to $205 billion, a significant increase from the previous $180 billion to $190 billion forecast. This news emerged as the key factor weighing on the stock price.
BofA Securities analyst Justin Post maintained a "Buy" rating on Alphabet with a price target of $430. He noted that, despite the negative market reaction to the raised capex, the cloud business's backlog, customer overconsumption, and expanding cloud margins all indicate that incremental investments are directly translating into revenue growth.
Cloud Business Explodes, Highlighting the Quarter
Google Cloud achieved an acceleration in growth this quarter that captured market attention.
Second-quarter cloud revenue reached $24.8 billion, up 82% year-over-year, not only significantly beating the expected 65% but also accelerating from the 63% growth in the first quarter. The cloud operating margin rose to 35.6%, also exceeding the market estimate of 31.3%, an increase of 270 basis points quarter-over-quarter and nearly 15 percentage points year-over-year.
The BofA Securities report pointed out that the strong performance of the cloud business is supported by several data points indicating sustainability: the cloud backlog grew 11% quarter-over-quarter and approximately 375% year-over-year, reaching $514 billion; customer consumption exceeded contractual commitments by over 50%, up from 45% in the first quarter; and the pace of new customer acquisition was more than double that of the same period last year.
Additionally, this quarter included new revenue from selling TPU chips to external customers. Management indicated that even excluding TPU sales, cloud business growth would still show "significant acceleration."
Google's model API now processes approximately 22 billion tokens per minute, a significant increase from 16 billion last quarter. The weekly active users for the AI agent development platform AntiGravity have exceeded 2.4 million. BofA Securities expects Google Cloud's revenue growth rate to further accelerate to 93% in the third quarter.
Search and Overall Results: Beat Expectations but Mixed Highlights
Overall, Alphabet's second-quarter GAAP earnings per share were $9.11, far surpassing the market estimate of $2.90. However, it's important to note that this included approximately $98 billion in other income, primarily from the revaluation of its investment in Anthropic, while the market had only expected $800 million. Excluding this one-time factor, the core business performance appears more realistic.
Search revenue was $63.3 billion, up 17% year-over-year, roughly in line with market expectations. This was a softer performance compared to the previous quarter's beat, and is seen by the market as a temporary signal of cooling in the recent AI-driven upside narrative.
Management also indicated that search revenue will face a higher year-over-year comparison base in the third quarter.
YouTube advertising revenue was $11.1 billion, up 13% year-over-year, exceeding the market estimate of $10.8 billion, partly benefiting from brand advertising demand related to the FIFA World Cup. In terms of operating margin, the second-quarter GAAP operating margin was 39.3%, below the market expectation of 40.3%, mainly dragged down by higher-than-expected G&A expenses—actual G&A spending was $6.46 billion, significantly above the market estimate of $5.1 billion. Management attributed this to several legal and other matters but did not provide detailed disclosures.
Soaring Capex and Negative Free Cash Flow: The Market's Biggest Worry
The negative market reaction to the quarterly results centers on the substantial upward revision of capital expenditure and its impact on cash flow.
Alphabet raised its fiscal 2026 capital expenditure guidance to $195 billion to $205 billion, an increase of about 8% from the previous guidance and significantly higher than the market estimate of $187 billion. BofA Securities expects free cash flow to be negative $16 billion in fiscal 2026 and also negative in 2027.
Meanwhile, Alphabet did not conduct any share repurchases in the second quarter, and free cash flow was negative $5.9 billion. After completing a $45 billion hybrid capital financing in June, the company plans to launch a $40 billion at-the-market (ATM) equity offering program in the third quarter. BofA Securities estimates this will lead to an approximate 1% sequential increase in diluted shares in the second half of the year.
BofA Securities analyst Justin Post pointed out that while these factors create short-term pressure, the increase in capex is directly linked to the rapid growth of the cloud backlog. The $514 billion backlog far exceeds the $15 billion incremental capex, suggesting that the logic of "more capacity equals more sales" still holds. He maintains his forecast for fiscal 2026 capex at approximately $200 billion and raised his fiscal 2027 capex forecast to about $300 billion, a year-over-year increase of roughly 51%.
Valuation and Rating: Current Price Still Attractive
BofA Securities maintains a "Buy" rating on Alphabet with a $430 price target, based on a 2027 adjusted GAAP EPS of $15.55 multiplied by a 27x P/E ratio, plus $11 per share in cash.
The report raised its fiscal 2026 net revenue forecast by 2% to $433.6 billion and EPS by 4% to $20.58. For 2027, it raised net revenue by 3% to $552.8 billion and EPS by 2% to $15.01.
At the after-hours price of around $332, Alphabet trades at approximately 22 times its 2027 GAAP EPS, in line with the company's 10-year historical average. However, BofA Securities expects 2027 revenue growth to reach 27%, far exceeding the 14% average from 2023 to 2025.
From a sum-of-the-parts valuation perspective, after stripping out assets like YouTube, the cloud business, Waymo, and cash, the implied valuation for Google's core advertising and Play businesses is only 13 times estimated 2026 earnings, lower than the S&P 500's 20 times.
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