Alphabet (GOOG +0.81%) (GOOGL +0.81%) has garnered some huge customer commitments for its cloud computing platform over the last few years. Though its revenue growth accelerated last quarter, with the top line rising 82% to nearly $25 billion, there's much more revenue to be earned -- $514 billion in cloud backlog, to be precise.
The company is spending heavily to ensure it acquires the compute capacity to fulfill all those contracts. It's committed to spending $811 billion, mostly on AI infrastructure. In other words, management is making a big bet that the cloud business will be the company's biggest growth engine for the foreseeable future.
Image source: The Motley Fool.
A bigger growth driver than search
Alphabet's search business is still its cash cow. It generated $63 billion last quarter, and it grew by an impressive 17%. In fact, Alphabet has seen its AI development pay off with strong revenue growth for the search engine, thanks to more relevant responses and ad placements, which have led to stronger user engagement and higher ad prices. Search grew faster than any other portion of the Google services segment last quarter.
Search also earns high operating margins. So, an incremental dollar generated by search produces more income than an incremental dollar from cloud computing or most other parts of Alphabet's business. Alphabet doesn't break out the details on search as a stand-alone business, but the services segment produced an operating margin of 41.8% last quarter. Search likely generates a higher operating margin than the overall segment.
With a growth rate in the high teens and an operating margin around 50%, search could contribute around $5 billion in quarterly operating income growth this year.
NASDAQ: GOOG
Key Data Points
Google Cloud might not be that far behind. Revenue growth is accelerating, and based on the company's ramp-up in capital expenditures, it could continue to accelerate through the back half of 2026. Operating margin has also expanded, although management warned it could temporarily contract as the company uses more third-party compute while building out its own capacity. Still, if revenue doubles and margins fall to 30% from 35.6%, cloud will add more than $5 billion in quarterly operating income in the back half of the year.
By next year, as operating margin expands again, cloud computing could certainly surpass search as the biggest source of growth for Alphabet.
The cloud is already the biggest factor driving the stock price
Alphabet might still be generating more income growth from search (for the time being), but its cloud computing operations are already driving the stock price.
When management increased its capital expenditure guidance range for this year from $185 billion at the midpoint to $200 billion at the midpoint, investors sent the share price lower. The magnitude of Alphabet's spending is a concern for many investors, its free cash flow fell into negative territory last quarter, and management's comments suggested free cash flow will "remain under pressure" in 2027.
But with a backlog that has reached $514 billion and which continues to grow quarter after quarter, Alphabet should be able to generate a very strong return on invested capital across all its spending. Even if it has to take on debt or issue equity to fund its data center build-out, it should produce returns well in excess of the cost of capital. Given the size of the AI build-out -- hundreds of billions of dollars -- the long-term cash flow from the cloud segment will absolutely dwarf that of the rest of the business in a few years.
Analysts expect Alphabet's total adjusted free cash flow (a metric that does not include stock-based compensation) to surpass its old high of around $50 billion by 2029 and reach $300 billion by 2031. The vast majority of that growth will come from Google Cloud.
Right now, however, investors can buy the stock on the cheap. The tech stock trades at just 17 times trailing earnings due to concerns about its cloud computing spending. Those fears may be overblown, and patient investors should be rewarded as cash flow comes roaring back.
