In this post, we take a deeper look at Google's earnings results for Q2 and share our thoughts on:
- Earnings results for Google Search and updates on the battle between Gemini and ChatGPT
- Google Cloud’s results, and what the increase to capex means in competitive context
- Threats to Google’s ecosystem—the one serious concern that remains for Google Stock
- Who benefits from Google’s $85 billion capex and the AI growth stock we like better than Alphabet
On May 7th of this year, during the Department of Justice’s antitrust trial against Google, Apple's Senior Vice President of Services, Eddy Cue, revealed in his testimony that Safari searches declined for the first time in 22 years. Mr. Cue attributed the decline to the rising popularity of AI-powered search and assistants such as OpenAI’s ChatGTP, Perplexity AI, xAI’s Grok, and Anthropic’s Claude. On the topic of the eventual transition from traditional search to AI-powered alternatives, Cue added, “There’s enough money now, enough large players, that I don’t see how it doesn’t happen.”
In response, shares of Alphabet fell 9%, erasing an estimated $140 billion in market value.
Since then, investors have been awaiting Alphabet’s Q2 earnings to provide clarity around the issue—and it has, at least for Google’s Search business. But other questions remain in terms of one area Google is losing major real estate, which we discuss below.
Search reported 12% YoY revenue growth of $54.2 billion, helping drive Alphabet’s total revenue to $96.4 billion, up 14% YoY. While OpenAI’s ChatGPT, Perplexity’s new Comet browser, the Department of Justice, and others deserve continued monitoring, Google’s resilience in this space is impressive.
On the Q2 earnings call, Alphabet stated that Google is successfully integrating AI Overviews into its core search experience. With 2 billion monthly users across 200 countries, AI Overviews contribute 10%+ additional queries for the searches in which they appear. For Google, this represents a value add and engagement driver, not a disruption.
Google’s Gemini and ChatGPT are battling to become the AI assistant of choice for consumers. To compare, Gemini has reached 450 million MAUs, up 100 million from March of this year, with daily requests surging 50% over Q1. But according to Google’s own data shown in court back in March of this year, ChatGPT had an estimated 600 million MAUs, and likely many more by now. Gemini is gaining ground, though still lags behind ChatGPT.
Alphabet also reported on its launch of AI Mode—a new option displaying as the first tab in Google’s main search menu, next to All, News, Videos, Images, and the rest—in the U.S. and India. The company said AI Mode has already amassed 100 million MAUs.
Capex Now 40% Higher Since the Start of 2025
While Google Cloud revenue reaccelerated four points to 32% to $13.6 billion—a welcome beat considering Q1 had seen a 2-point sequential deceleration —the big news on Cloud is the reported $10 billion increase to capex, now up to $85 billion. This is 40% higher than the $60 billion capex estimate coming into the year, signaling Alphabet's willingness to spend on AI to drive accelerating cloud growth.
Similar to Oracle stock, this surging capex is weighing heavily on free cash flow, and will likely continue to pressure free cash flow in the upcoming quarters. Operating cash flow rose just 4% YoY to $27.7 billion in Q2, yet free cash flow declined (61%) YoY to $5.3 billion. While TTM free cash flow is still up 10% YoY to $66.7 billion, the market is forward looking, and this capex hike implies TTM free cash flow will continue to trend much lower over the next few quarters.
It is understandable why Alphabet is willing to increase its capex, as it is beginning to witness increasing operating leverage in Google Cloud and seeing AI usage proliferate across its core Search business. For example, AI Overviews now serves 2 billion users and processes 980 trillion tokens monthly, doubling since May, a scale which helps explain the explosive compute costs driving Google’s massive investment in Cloud.
Cloud operating margins have expanded significantly, up more than nine points from 11.3% to 20.7%, as operating income rose 141% YoY to $2.8 billion. Prioritizing AI investments in an effort to drive Cloud growth of >30% could see the segment reach a $120 billion run rate by mid-2028, more than double its $54 billion run rate this quarter. Should operating margins begin to expand towards the high-20% to 30% level by mid-2028, versus AWS in the high-30% range, Cloud could generate $30 billion in annual operating income, or more than 3x from today.
This represents more than one-quarter of current company-wide operating income, or a potential massive driver of profitability in the future — the point here is that Alphabet is essentially sacrificing some FCF growth in the near-term and spending heavily in an aim to reap the rewards of a much larger, fast-growing Cloud segment in the future.
Another market reality adding pressure to Google’s Cloud and AI initiatives is the fact that Microsoft Azure has already set a high bar and is leading the race to monetization by a substantial margin. Whereas Google processes huge volumes of tokens—980 trillion, a figure that has doubled since May of this year—Microsoft’s deeply established enterprise relationships with hundreds of millions of users has unlocked user and revenue growth.
Microsoft’s fiscal Q3 report helped cement the company as the strongest AI player in the hyperscale crowd due to its focus and dominance across enterprise software offerings and deep AI integrations aided by its partnership with OpenAI.
I/O Fund covered Microsoft’s impressive Q3 2025 earnings and Azure’s outperformance on May 15th, which you can read for free here: Microsoft Stock Surges After Q3 2025 Earnings: What Separates Azure from AWS, Google CloudMicrosoft Stock Surges After Q3 2025 Earnings: What Separates Azure from AWS, Google Cloud
One Serious Concern Remains for Google’s Stock
The intense regulatory pressure on Google to open its ecosystem, even as leading AI assistants are knocking on the door, is a lot for Google to overcome. The DOJ’s proposed remedy—Alphabet divesting itself of the Chrome browser—comes as rivals like Perplexity, OpenAI, and Anthropic are developing assistants that can integrate with other Android apps. The pressure on Google to open its ecosystem is mounting, and the competition is already finding their way in.
Primarily, it’s the loss of Google Search being the default search engine on Samsung devices that poses a larger threat to the company, in our opinion. This is because any loss of real estate – especially on mobile – during a time when there are fierce rivals only creates more headwinds for the stock.
As was reported in early June, Samsung is entering a deal with Perplexity to become the default AI search engine on their devices. According to sources such as Bloomberg, Samsung plans to preload the Perplexity AI assistant and app onto its smartphones, with its AI search built directly into Samsung’s Internet Browser. There could also be AI-powered operating systems built later down the line for multi-agent platforms. This shift could happen as soon as 2026.
Here are a few of the key developments that could lead to Google Search losing market share on mobile, specifically, in the next 1-2 years:
- OpenAI, Perplexity, and Anthropic are developing assistants that can integrate with other Android apps, undermining Gemini usage on devices.
- OpenAI has expressed interest in acquiring the Chrome browser to boost already strong usage of ChatGPT, while Perplexity recently launched its own agentic browser, Comet.
- On April 1st, Google signed a new, non-exclusive agreement with Samsung that includes no restrictions on the smartphone manufacturer loading alternative search products.
- Anthropic recently introduced the ability of its Claude assistant to integrate with Google Workspace, and OpenAI will soon introduce its own assistant that can connect with Android apps and Google Workspace.
- While Google is also in talks with Apple to integrate its Gemini assistant with Siri, Google Search is unlikely to enjoy the "default" status that it has enjoyed for many years on iPhones, given that Apple is also in talks with other AI rivals.
The takeaway is that Google’s ability to leverage one of its key distribution channels during the generative AI revolution is already compromised. The real threat kicks in when Android smartphone users have the choice to opt for third-party digital assistants over Gemini—subsequently undermining Google’s advertising revenue growth.
One Stock that Will Benefit from Google’s $85 Billion Capex
As I pointed out in the Bloomberg interview above, the best way to position is with stocks that directly benefit from Big Tech’s increase in capex.
While Alphabet is still a very solid business with the major advantages outlined in this analysis, its $85 billion capex commitment could require years to generate meaningful returns in the Cloud. Therefore, we prefer to invest in companies that benefit strongly from capex over those that spend heavily on capex.
Keep in mind that some companies will benefit from capex across all of Big Tech – therefore, the $85 billion from Google is just the start to the tailwinds for specific AI hardware stocks. Investors should factor in there is similar spend from Big Tech: Alphabet, Amazon, Meta, Microsoft and Apple.
Below, my firm outlines a direct beneficiary of Google’s enormous capex spending – which was increased 40% this year alone and was raised $10 billion in the most recent earnings report. After all, one stock’s loss is another stock’s gain.
For investors hungry for more near-term growth, we recommend Broadcom (AVGO) as it directly supplies tensor processing units (TPUs) to Google.
Alphabet is a primary custom silicon chips (ASICs) customer for Broadcom, with HSBC estimating the giant will account for nearly three-fifths of Broadcom’s ASICs shipments in its fiscal 2026.
With Alphabet’s newest TPU version, Ironwood, expected to carry a premium $13,000 ASP, versus Broadcom’s other customers at ~$5,000 , this could drive a 128% YoY increase in ASICs revenue to $28.4 billion (not including AI networking). Alphabet’s capex increase in Q2 further cements this story into Broadcom’s AI growth thesis for next year.
Why Big Tech Is Chasing Cheaper Inference
For the providers in the AI ecosystem, monetizing GPUs depends on inference, and thus revenue becomes a function of GPUs and tokens and profits become a function of cost. Nvidia’s Blackwell offers a massive leap in performance and can train models such as Meta’s Llama 3.1 405B in as little as 27 minutes, yet the cost advantages offered by custom silicon can translate into higher margins in the long run from lower inference serving costs.
For example, Google recently announced that its upcoming seventh-gen TPU Ironwood is its “most performant and scalable custom AI accelerator to date, and the first designed specifically for inference.” Ironwood comes in two sizes, a 256 and a 9,216 chip configuration, with the larger size offering up to 42.5 exaflops of performance.
Google adds that Ironwood offers 2x the performance per watt as last-year’s generation Trillium, with 6x more HBM and 4.5x the HBM bandwidth. This allows it to deliver more capacity per watt at a time when power is a primary constraint, and provide customers with more cost-effective AI workloads.
This is exactly what Broadcom sees arising from this inference growth curve, as CEO Hock Tan asserted that the company has quite a bit of visibility into “increased deployment of XPUs next year, much more than we originally thought and hand-in-hand with it, of course, more and more networking.” The necessity of networking in larger clusters means demand is likely to remain robust even given custom silicon will not keep pace with Nvidia’s merchant sales into the hundreds of billions.
Higher-than-expected deployments of custom silicon combined with strong demand for networking should provide robust tailwinds for AI revenue growth beyond 2026. Broadcom currently has enough visibility to place possible demand acceleration for 2H 2026 on the table, and this could easily persist through 2027 and beyond should inference demand flourish and as the path to 1 million accelerator clusters materializes.
Assuming Broadcom can maintain another 60% YoY growth in FY27 on stronger demand and potential conversion of its 4 current prospects, AI revenue would close in on $50 billion, or up to 60% share of revenue. Even if growth then slows to 30% YoY in FY28, Broadcom would still be more than doubling its AI revenue to $65 billion in just three years.
Broadcom Reports 170% YoY Growth in AI Networking
Broadcom has cemented itself in second place in AI revenue as it closes in on $20 billion this fiscal year in AI revenue — with a line of sight toward $30 billion by the end of fiscal 2026. AI revenue accounted for more than 50% of Semiconductor revenue for two quarters in a row and nearly 32% of total revenue in Q2.
AI semiconductor revenue rose 46% YoY to $4.4 billion, in line with management’s guidance. Although this was a deceleration from 77% YoY growth in Q1, Broadcom forecast $5.1 billion in AI revenue in Q3, pointing to a rebound to 60% YoY growth – marking ten consecutive quarters of growth.
In the current quarter, the 46% AI semiconductor growth was driven by networking, which was up 170% YoY and represented 40% of AI revenue. In the opening remarks, the CEO stated the following regarding this outsized growth: “As a standard-based open protocol, Ethernet enables one single fabric for both scale out and scale up and remains the preferred choice by our hyperscale customers. Our networking portfolio of Tomahawk switches, Jericho routers and NICs is what's driving our success within AI clusters in hyperscalers.”
Q3’s guidance was ahead of some analyst expectations for $4.9 billion in AI revenue in the quarter, ticking higher as Google’s TPU v7p (Ironwood) begins to ramp. Q3 would also mark the largest sequential growth in over a year on a dollar basis, at ~$700 million.
Additionally, analysts look to already be penciling in further strength in Q4, with Bernstein’s Stacy Rasgon suggesting that Broadcom could be eyeing $5.8 billion in AI revenue in Q4 assuming it sustains 60% YoY growth. Given that Broadcom’s 1H revenue was up more than 57% YoY, this seems a reasonable assumption, especially considering management is eyeing near 60% growth in FY26.
More importantly, AI’s strength is masking persisting softness in non-AI revenue, which could continue to be pressured due to Broadcom’s high consumer exposure. Broadcom noted that non-AI revenue “is close to the bottom” but it “has been relatively slow to recover” with revenue down (5%) YoY to $4 billion in Q2.
Despite this weakness extending into Q3 with revenue expected to be flat QoQ at $4 billion, semiconductor revenue is accelerating – growth accelerated from 11% to nearly 17% in Q2, with the $9.1 billion semiconductor revenue guide pointing to an acceleration to nearly 25% growth in Q3.
Should non-AI revenue soon find the bottom and begin to recover, this will provide support for continued Semiconductor growth. However, any persisting weakness in non-AI stemming from this elevated consumer and Apple exposure that AI revenue must absorb presents a real risk that investors should keep in mind through the rest of the year. Broadcom is also one of the more exposed semiconductor companies to China with tariffs, with more than $10 billion in revenue from the nation in fiscal 2024.
Broadcom Stock to See Lift from AI Inference
Broadcom is aiming to capture growing inference tailwinds, with management explaining that the recent surge in inference demand is driving increased confidence in their FY26 AI revenue growth rate.
CEO Hock Tan said that Broadcom’s hyperscale clients are “doubling down on inference in order to monetize their platforms,” and as a result, he expects Broadcom could “actually see an acceleration of XPU demand into the back half of 2026 to meet urgent demand for inference on top of the demand we have indicated from training.” This new dynamic is what is driving Tan’s confidence in stronger growth in FY26, saying that he now anticipates the “fiscal 2025 growth rate of AI semiconductor revenue to sustain into fiscal 2026.”
This commentary plus potential demand acceleration in 2H 26 suggests that Broadcom has visibility into $30 billion AI revenue potential next year. Broadcom has not provided a full FY25 AI revenue guide yet, but it is on track to deliver approximately $19 to $20 billion in AI revenue in FY25, up ~60% YoY assuming 60% growth to $5.9 billion in Q4.
Maintaining 60% growth through FY26 would project AI revenue to $30 to $32 billion. This trajectory indicates Broadcom is likely driving AI revenue ahead of expectations over the next four to six quarters, with Morgan Stanley saying that $26 to $30 billion in AI revenue is “higher than what is in Street models.” Evercore is modeling 58% AI revenue growth in FY25 and 50% in FY26, implying $28.9 billion.
Valuation is Too High for Broadcom
Broadcom is a key beneficiary of Google’s capex yet the stock is richly valued.
On the top-line, Broadcom trades at nearly 22x forward revenue, a 5% premium to Nvidia’s 21x multiple. AVGO stock was at a 14% premium heading into Q2’s earnings. This is also 85% higher than Broadcom’s 5-year average 11.8x forward revenue multiple.
On the bottom line, Broadcom trades at 43.8x forward earnings, an 8% premium to Nvidia. Broadcom has strong margins – 65% adjusted operating margin and 52% adjusted net margin – driving strong EPS growth, at a 25% expected CAGR through FY27; however, the custom silicon ramp presents some headwinds to gross margin as it grows its mix share.
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Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
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