Google & ServiceNow – Investment Issues

Google Q2 26 – Valuation supported by hot air rather than water.

• An excellent top-line performance was spoilt by the first negative cash flow quarter in over 20 years and the illusory security of a series of unrealised investment returns that will evaporate at the first hint of trouble.
• Google reported Q2 26 revenues / Adj-EPS of $119.8bn / $3.39, comfortably beating expectations of $117.1bn / $2.88 as Google Cloud started to see some results from the huge increases in investments that Google has been making for the last 12 months.
• GAAP EPS was $9.11 largely as a result of a $99.0bn unrealised gain on equity investments, largely as a result of its positions in SpaceX and Anthropic, to name but two, which have all seen very large increases in their valuations.
• It is important to note that these gains are unrealised, meaning that there is no cash flow attached to them and that they could easily be reversed.  
• This was also a major factor in how such a large profit could be quickly reversed in the cash flow statement, where $44.9bn was spent on capital expenditure as part of Google’s AI roll-out.
• The good news is that Google Cloud put in a mighty performance with growth accelerating to 82% YoY to $24.7bn with a 35.5% operating profit margin, up from 20.7% a year ago.
• However, Google also stated that it would increase its investments still further, with capex now projected at $195bn – $205bn, up from $180bn – $190bn, which was not well received at all.
• In order to see a good return from these investments, Google Cloud needs to continue to grow at a breakneck pace as well as deliver excellent operating margins for some considerable time to come.
• The problem is that what was once supported by steady growth and terrific cash flow is now propped up by speculative unrealised gains as well as expectations and hopes that the promised returns from colossal spending will materialise as promised.
• The spending is also degrading the quality of Google’s once impregnable balance sheet and lays it open to difficult times when the correction inevitably comes.
• The real winners here are the suppliers of the AI boom, which is predominantly the semiconductor industry, as this is where all the cash has gone and where it will continue to accumulate.
• With hyperscalers still increasing capex, this remains the place to be positioned.

ServiceNow Q2 26 – On the nose.

• ServiceNow did precisely what it needed to with a beat and raise, reinforcing my confidence further that this company will thrive as a result of the AI boom rather than be destroyed by it as the market seems to think.
• Q2 26 revenues / Adj-EPS were $4.0bn (up 24.5% YoY) / $0.90 (up 11% YoY), slightly ahead of expectations of $3.9bn / $0.86.
• Growth has continued because no enterprise in its right mind is going to let an LLM roam willy-nilly over its corporate IT systems, as this has already been demonstrated to be a disastrous idea.
• ServiceNow provides the “harness” and the “orchestrator” that many of the frontier labs are now talking about, which keeps LLMs under control, sends the right job to the right model and keeps track of all the actions that they take.  
• Many others are also starting to also make these claims, but because ServiceNow is already a well-established and trusted supplier, enterprises are continuing to migrate towards its Control Tower product rather than go looking elsewhere.
• This is why revenues beat expectations in Q2 26, why expectations for 2026 have been increased somewhat and why 2030 targets are also continuing to be lifted.
• 2026 revenue guidance has been raised for the second time to 22.5% YoY, with very healthy profitability and cash flow expected to continue.
• These are all very small increases, which point to very careful expectations management, but with the share price where it is today, the only thing that matters is that growth continues.
• With every passing quarter, the argument that everyone is going to stop spending with ServiceNow gets weaker as each report is another proof point that the market has got this one wrong.  
• However, the market can remain irrational for far longer than I can stay solvent, which is why my large position in ServiceNow remains unleveraged and has no time element in terms of return.
• My expectation is that at some point, the market will begin to separate the winners (Salesforce, Snowflake, ServiceNow, SAP and Adobe) from the losers (like IBM and consumer software), and it is at that point that valuations will begin to diverge.
• Hence, there remains a very good opportunity in ServiceNow, which I value at $244 per share on a DCF basis with a 9% discount rate.