Toyota (TM 0.99%), the world's largest automaker by volume, recently announced that it had sold a combined 917,500 vehicles in the Chinese market in 2013, up 9.2% compared with 2012. Although Toyota serves many other markets, its performance in China is becoming increasingly important for investors.

In 2012, Toyota's sales in China declined for the first time ever, amid a countrywide anti-Japan groundswell brought about by the territorial dispute between Japan and China. And while Toyota has yet to fully recover, its 2013 sales uptick is a positive signal. More importantly, however, Toyota is tightening its grip on China in preparation for the next big wave of demand in the booming Chinese auto industry.

Toyota reinvents itself to capture growing demand for green cars
The latest Scotiabank Global Auto Report indicates that China will continue to be the main driver of global volumes. A separate report by the China Association of Automobile Manufacturers, however, forecasts slower growth in 2014. Deliveries in China in 2014 are expected to grow 10%, compared with 14% growth in 2013. The association contends that increased pollution controls will contribute to the pent-up demand. 

The pollution crisis in China means that the next big market factor in the auto industry will be green cars. All the big auto players -- including Toyota -- have environmentally friendly products. So what makes Toyota stand out in this regard?

Toyota has reinvented itself for the Chinese market. In November 2013, it announced that it had inked a deal to develop components for hybrid vehicles with two major Chinese automakers; First Automobile Works and Guangzhou Automobile Group. This deal is the very first of its kind;  Toyota doesn't share critical hybrid technology with foreign partners.

The unique nature of this deal not only gives Toyota an opportunity to meet the rising demand for green cars, but also presents two unique benefits that give the automaker a competitive advantage and a chance at further growth going forward.

First, Toyota will add key Chinese automakers to its value chain. By sharing technology with Chinese automakers, Toyota will be able to build stronger networks in the Chinese industry. This will not only make it easier for Toyota to conduct business in China, but also dampen any anti-Japan sentiment the company might otherwise face.

Secondly, Toyota will be able to cut costs significantly. Previously, Toyota would make key components such as motors and batteries in Japan, where costs are high relative to China. This pushed up the price of green offerings such as the Prius hybrid, explaining its lackluster performance in China. However, by making components for hybrid cars in China, Toyota will significantly cut back on costs, allowing it to price its products competitively.

Brighter long-term prospects
Comparing Toyota with Ford, the latter has shown greater growth in China over the past year. Ford (F 0.41%) sold 935,813 vehicles in 2013. Although that came very close to Toyota's 917,500 units, Ford recorded a yearly gain of 49% in sales, far exceeding Toyota's 9.2% gain.

Nonetheless, Toyota has a brighter long-term outlook when stacked against Ford. Toyota is coming from a lower position (consider the anti-Japan sentiment and sales decline in 2012) and has aligned itself to successfully capitalize on the next big trend in the Chinese market- green cars. This suggests that it's likely to have greater upside potential in the Chinese market relative to Ford. As a long-term buy-and-hold investor, this is crucial; you're looking for sustainable growth, rather than short bursts.

Ford recently announced a 25% increase in its annual dividend. This is the second consecutive annual dividend increase since the automaker revived its dividend payouts in 2012. As is, the new increment brings the annual dividend to $0.50 a share. This pushes Ford's yield above 3%, which is more attractive than Toyota's 2.10% yield.

However, considering that Ford's dividend policy is not as mature as Toyota's, a sudden influx of income-investors could very easily interfere with that yield. Toyota, on the other hand, offers more clarity into the future.

If Toyota's efforts in China pay off, the automaker may be able to further shore up its future growth prospects. Moreover, Japan's new economic policies will continue to weaken the Yen relative to other currencies, allowing Toyota to sustain strong demand from other global markets, and providing a crucial lift for the entire business at a time when China's inclination to green cars promises immense potential. This scenario gives Toyota the perfect backdrop for sustainable growth.