Alphabet 2Q26 earnings: Free cash flow turns negative. Should investors be worried?

• Alphabet delivered a strong Q2 2026, with revenue rising 24% YoY to USD 119.8 billion, ahead of consensus estimates of USD 117.0 billion. Diluted EPS came in at USD 9.11, although this was significantly boosted by a USD 99.0 billion unrealised gain on equity investments; excluding this benefit, adjusted EPS was approximately USD 2.85, broadly in line with estimates.

• Alphabet raised its full-year 2026 CapEx guidance by USD 15 billion to USD 195–205 billion, pushing free cash flow into negative territory for the first time in the company’s history, with continued pressure expected as AI infrastructure investment ramps up.

• Google Cloud remains a key AI growth engine, while we believe concerns over Alphabet falling behind in the frontier AI race are overstated, given its full-stack AI strategy and strong demand for Gemini.

• AI is strengthening Google Search, with Search revenue growing 17% YoY as AI-powered features drive higher engagement while improving the relevance and effectiveness of advertising.

• We maintain our USD 438 target price, implying 32% upside from Alphabet’s post-market price of USD 331.91. We believe Alphabet’s strong AI monetisation opportunities and robust balance sheet can support attractive long-term returns on its elevated AI investments.

Q2 2026 earnings highlight

Alphabet delivered a strong quarter, with revenue rising 24% year-on-year to USD 119.8 billion, ahead of consensus estimates of USD 117.0 billion. This marked the company’s 12th consecutive quarter of double-digit revenue growth.

Google Services revenue increased 15% YoY to USD 94.5 billion, with Google Search & Other revenue up 17% to USD 63.3 billion, YouTube advertising revenue rising 13% to USD 11.1 billion, and Google subscriptions, platforms and devices revenue increasing 15% to USD 12.9 billion. Meanwhile, Network advertising revenue declined 1% YoY to USD 7.3 billion.

Google Cloud remained the fastest growing business segment, with revenue surging 82% YoY to USD 24.8 billion, led by an increase in Google Cloud Platform (GCP) across enterprise AI Solutions and enterprise AI Infrastructure, as well as core GCP services.

Meanwhile, Other Bets revenue rose 2.4% year-on-year to USD 382 million.

Alphabet’s diluted earnings per share (EPS) came in at USD 9.11, significantly above consensus estimates of USD 2.31. However, the figure was boosted by USD 99.0 billion in unrealised gains from the company’s equity securities portfolio, likely reflecting the appreciation of investments in companies such as SpaceX and Anthropic. Excluding this non-operating benefit, diluted EPS would have been approximately USD 2.85, broadly in line with consensus estimates of USD 2.90.

Table 1: Alphabet Q2 earnings

	2Q26	2Q25	Beat/Miss vs Estimate	YoY change
Revenue	119,796	96,428	2.4%	24.2%
Operating Income	40,770	31,271	0.55%	30.4%
Net Income	112,107	28,196	216.4%	297.6%
Earnings per Share	9.11	2.31	213.7%	294.4%
Source: Alphabet 2Q Press Release, Bloomberg. Data as of 22 July 2026. Figures are in USD millions except percentages and per share amounts.

Alphabet raised its full-year 2026 CapEx guidance to USD 195 billion–205 billion, up from USD 180 billion–190 billion previously, citing an acceleration in the delivery of capacity to meet growing demand. Management also continues to expect CapEx to increase significantly in 2027, though no details were provided.

Elevated CapEx weighed heavily on free cash flow, which turned negative for the first time in the company’s history, at negative USD 5.9 billion for the quarter. Management expects free cash flow to remain under pressure as it continues to invest heavily in technical infrastructure.

Shares fell 2.92% in after-hours trading to USD 331.91, likely reflecting investor concerns over the higher CapEx outlook and the associated pressure on free cash flow.

Cloud momentum remains strong as Alphabet leverages its full-stack AI advantage

Google Cloud delivered another exceptional quarter, with revenue surging 82% year-on-year in 2Q26, accelerating from 63% growth in the previous quarter. The momentum is underpinned by strong demand for AI infrastructure and AI solutions, with Cloud backlog increasing 11% sequentially to USD 514 billion from USD 462 billion in 1Q26. Approximately 50% of the backlog is expected to be recognised as revenue over the next 24 months.

As highlighted in the previous quarter, Alphabet will be delivering its TPUs (Tensor Processing Unit) to customer data centres. It began recognising revenues from TPU system sales for the first time in the second quarter and expect most of the revenue to be recognised in 2027.

Cloud profitability also continued to improve, with operating margins expanding to 35.6% in 2Q26 from 20.7% a year ago and 32.9% in 1Q26. That said, near-term margins are likely to come under modest pressure as Alphabet turns to third-party capacity to bridge the gap while it builds out its own infrastructure. This includes a multi-year deal reportedly worth approximately USD 30 billion to lease computing capacity from SpaceX, with Alphabet paying around USD 920 million per month through June 2029. While external capacity “may be very high”, management views such “bridge deals” as highly ROI-positive over the multi-year horizon, as they allow the company to serve large customers and capture demand during a period of extraordinary AI infrastructure growth.

Beyond infrastructure, concerns have recently emerged over whether Alphabet is falling behind at the AI model frontier. While competitors such as Anthropic and OpenAI continue to launch new models, including Fable 5 and GPT-5.6, and Chinese AI companies such as Moonshot AI have introduced models such as Kimi K3, Google has delayed the launch of its flagship Gemini 3.5 Pro after reportedly failing to meet its internal goals. However, we believe investors should not be overly focused on which model is leading at any given point, as the frontier remains highly dynamic and leadership can shift quickly. While Google may not lead across every benchmark and has acknowledged areas for improvement, particularly in coding, management noted that Gemini remains at the frontier across many attributes and expressed confidence in the progress of its upcoming Gemini 4 model. Alphabet has also indicated that it intends to accelerate its model release cadence as it continues to develop Gemini 4.

Moreover, Alphabet is positioning itself across the broader AI market rather than competing solely for leadership at the frontier. The company aims to offer leading models across different performance and price points, with strong demand for its workhorse Gemini Flash series, which it believes offers an attractive balance between performance and cost. This strategy allows Alphabet to target a wider range of AI use cases, from frontier applications to more cost-sensitive workloads.

Overall, we believe Alphabet remains well positioned to benefit from the continued adoption of AI. Demand for its models remains strong, with Gemini models now processing 22 billion API tokens per minute, up from 16 billion just one quarter ago. Nearly 90% of Fortune 100 companies are now using Gemini Enterprise, while the Gemini app has reached 950 million monthly active users, with daily active users tripling over the past year. Importantly, Alphabet’s opportunity extends beyond its models, with its full-stack approach spanning proprietary chips, cloud infrastructure, AI models and applications. This enables the company to capture value across multiple layers of the AI ecosystem and provides multiple avenues for monetisation, reducing its reliance on any single model or product to drive its long-term AI growth.

AI is strengthening Search engagement while opening up new avenues for monetisation

Google Search continued to deliver strong growth with revenue rising 17%, as AI enhances both user engagement and monetisation. Google recently brought AI Overviews and AI Mode together into a more seamless search experience, with AI-powered features driving an incremental increase in overall search queries. Since expanding AI Mode globally last October, it has surpassed 1 billion monthly active users. Importantly, improvements in engineering and hardware optimisation have also reduced the cost of generating AI Mode responses to their lowest level since launch, even as Google continues to introduce more advanced AI capabilities.

AI is also improving the quality and relevance of Search advertising. By leveraging Gemini’s advanced reasoning capabilities to better understand the nuances of longer and more detailed queries, Google achieved a 20% improvement in its ability to show highly relevant ads. Meanwhile, advertisers adopting AI-powered campaigns such as AI Max and Performance Max (PMax) are seeing an average of 15% more conversions or value from Search at a similar return on ad spend (ROAS). For example, AAA Auto Club Enterprises used AI Max to personalise creative assets and capture demand from increasingly detailed insurance searches, resulting in a 17% improvement in conversion volume and an 11% reduction in cost per lead.

Google is also continuing to test and deploy new ad formats within AI Mode as it seeks to monetise the evolving search experience. For example, text ads can now include relevant links based on the user’s query and conversation, while Direct Offers allows partners such as IHG Hotels & Resorts to present special deals as users plan their trips. These initiatives could create new opportunities for Google to monetise AI-powered Search by making ads more relevant and better integrated into the user’s search journey.

That said, investors should be mindful that YoY growth comparisons may look less favourable in 3Q26, as Alphabet will begin lapping a period of accelerated Search performance that started in 3Q25. This could create a tougher comparison and potentially weigh on reported YoY growth, even if underlying Search demand and AI-driven engagement remain healthy.

Strong AI monetisation supports Alphabet’s long-term growth despite higher CapEx

Overall, Alphabet delivered a strong quarter that was perhaps overshadowed by the increase in its 2026 CapEx guidance. While we expect free cash flow to remain negative over the coming quarters as Alphabet ramps up investments in AI infrastructure, we are not overly concerned by the near-term impact on cash generation. These investments are increasingly translating into tangible monetisation opportunities across the AI ecosystem, from strong demand for Google Cloud to improved Search engagement and advertising performance.

Furthermore, Alphabet's strong net cash position provides significant financial flexibility to fund its elevated AI infrastructure investments, reducing concerns around balance-sheet risk despite the sharp increase in CapEx.

We maintain our target price of USD 438 for Alphabet, implying 32% upside from its post-market price of USD 331.91, and reiterate our Buy recommendation on the stock.

Table 2: Projections for Alphabet’s earnings

Alphabet	2025	2026E	2027E	2028E
Earnings Per Share (EPS)	9.2	14.4	15.3	18.3
Earnings Growth YoY	16.6%	55.6%	6.6%	19.3%
PE Ratio (X)	33.9	23.1	21.7	18.2
Target Price (based on a fair PE of 24X)				438
Upside Potential				32.0%
Source: Bloomberg Finance L.P., iFAST Estimates Data as of 23 July 2026

Figure 1: Share prices are driven by earnings growth in the long run

Declaration:

This research report was prepared with the assistance of artificial intelligence (AI) tools. iFAST Financial Pte Ltd does not rely exclusively on AI for content generation; the content of this report – including all investment theses, ratings, price targets and conclusions – has been independently reviewed and verified by the research analyst(s) to ensure accuracy and professional integrity.

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a NIL position in the abovementioned securities. The analyst who produced this report holds a position in Alphabet.