Google was downgraded on Friday after analysts expressed concerns over the company's spending and non-core businesses, sending shares of the Internet giant plummeting.
Morgan Stanley analyst Scott Devitt cut his rating on Google to Equal Weight from Overweight, and trimmed his price target to $600 from $645.
Shares of the company slid nearly 3 percent to $533.65 by midday on the Nasdaq stock exchange. Since January, the company has been down by 10 percent.
The company's investment into peripheral businesses, such as YouTube and Chrome, among others, are outpacing the returns, Devitt explained, putting pressure on Google's margins.
We believe the consensus is too optimistic on the net revenue contribution of newer businesses, such as DoubleClick, YouTube, AdMob, Android Market, and mobile search, Devitt told investors.
Margins were also poised to take a hit given the company's aggressive hiring plans.
The company is on track to hire 7,000 employees this year, up from the analyst's prior estimate of 4,000 net additions. Couple that with rising operational costs per employee rising to $450,000 in Q1 from just $330,000 in 2009.
Additionally, Google is now spending more than a billion on advertising a year, after years of holding back on advertising.
As a consequence, he sees the company's margin being just 53 percent this year and 51 percent next year, versus a prior expectation for 55 percent and 54 percent, respectively.
Google's primary revenue driver has been the advertising it has derived from its successful core search engine. Most of the company's revenue upside will come from better management of this, but there is some hope in some of its new ventures.
Just last week Google unveiled a new social network, Google+, pitting the company against rival Facebook and others.
Devitt added that it's too early to tell if Google's forays into e-commerce and social networking will pay off, but it does hold promise.
We are encouraged by the early progress of Google Plus and Google Offers, but Google faces stiff competition from incumbents who have a first mover advantage. The pay-off of such endeavors may be longer-term in nature.