Summary of Key Points
China's automotive industry has taken the lead globally in terms of sales volume and the penetration of new energy vehicles (for example, new energy vehicles accounted for 60% of the global market from January to May 2026). However, automotive stocks have continued to decline—BYD, despite being the top seller, has seen its stock price fall by more than 10%, while GAC and SAIC have reached multi-year lows, and new entrants in the industry have generally experienced a drop of over 30%. The fundamental reason is not that the industry is failing, but rather that the market's logic for pricing automotive stocks has changed: from focusing on scale (sales volume and revenue) in the past to emphasizing free cash flow (FCF) as the key indicator. Different companies are facing varying valuations due to their FCF capabilities. It will take two signals—the clearance of weaker companies and the establishment of software licensing rights—for valuations to truly bottom out.
I. Why do stocks decline even when sales increase? — The change in valuation logic
In the past, automotive stocks were considered "growth stocks," with the market focusing on future potential: for instance, as new energy penetration increased from 0% to 60%, stock prices could rise even if profits were not immediate, as long as sales and revenue grew (valued using the price-to-sales ratio (PSR)). However, currently:
1. Price wars erode profits: After Tesla cut prices in 2023, the industry's profit margin dropped from 7.8% in 2017 to 3.4% from January to May 2026 (2 percentage points below the industrial average), meaning selling cars is no longer profitable or even results in losses.
2. Profits are being taken by upstream suppliers: CATL's net profit in Q1 2026 was 20.7 billion yuan (a 48.5% increase), but the total profit of the automotive manufacturing sector decreased by 17%, with most of the profits going to upstream players in battery and chip production.
3. Shift from growth to maintenance: With a national car ownership of 370 million units, the focus has shifted from replacing fuel vehicles to competing for market share, meaning increased sales do not necessarily equate to value growth (for example, more sales may require discounts and additional marketing efforts, which consume cash).
Therefore, the market no longer asks "how many cars you sold," but rather "how much money you actually keep after selling them"—this represents the shift in valuation from focusing on scale to cash flow.
II. The new benchmark: What is free cash flow (FCF)?
Simply put, **free cash flow = company earnings (operating cash flow) - capital expenditures for expansion.* For example, BYD earned 167.8 billion yuan in cash in 2025 but spent 156.8 billion yuan on building factories and expanding overseas, resulting in a negative FCF of -97.7 billion yuan.
Why is FCF important?
- Book profits may be misleading: For instance, including inventory held with dealers as revenue without the actual payment received; or profits earned through subsidies, which are not indicative of true performance.
- FCF is the real money: It can be used for dividends, debt repayment, and risk mitigation, providing a company with resilience during economic cycles.
The market now uses FCF to price automotive stocks (P/FCF: market value divided by free cash flow). Leading companies with sustainable FCF are valued at around 10-15 times their FCF; if FCF is negative, other metrics such as the price-to-book ratio (PB) or the price-to-sales growth ratio (PSG) are used.
III. Different fates for four types of automotive companies
Based on FCF capabilities, automotive stocks can be categorized into four groups:
1. Transformation-struggling companies (SAIC, GAC):
- Issues: Joint venture profits have declined due to competition from domestic manufacturers, and their FCF remains negative.
- Valuation: Based mainly on assets (PB), but these assets are depreciating (joint venture equity is less valuable), leading to continuously declining stock prices.
- Outcome: They will either need to be cleared out or successfully transform; otherwise, it will be difficult for them to turn things around.
2. Huawei-dependent companies (Sailis, Jianghuai):
- Feature: Profit growth depends on cooperation with Huawei; FCF has just turned positive, but profits have stagnated (Sailis' profit only increased by 0.18% in 2025).
- Valuation: Downgraded from "technology stocks" (30-50x PE) to "manufacturing stocks" (8-12x PE) due to the reduced scarcity of Huawei's platform model.
- Key factor: Whether cooperation with Huawei can generate sustained profits.
3. Vertical integration leaders (BYD, Geely):
- Advantages: Own battery and supply chains (BYD) or strict financial discipline (Geely's FCF yield was 6.3% in 2025).
- Valuation: Most suitable for FCF-based pricing; as capital expenditures peak (e.g., by stopping excessive factory construction), FCF can turn positive.
- Confidence: High potential, with BYD having a cash reserve of 167.8 billion yuan and Geely showing stable profitability.
4. New entrants in need of validation (NIO, Li Auto, Xpeng):
- Current situation: Most have negative FCF and are still losing money; although Xpeng's FCF has turned positive, the profit per vehicle is only 900 yuan, raising doubts about sustainability.
- Key factor: The company that can first show a timeline for turning FCF positive will be revalued first.
- Differentiation: NIO's losses are narrowing, but Li Auto's pure electric investment gap is widening, and Xpeng's profitability is fluctuating.
IV. When will automotive stocks stop declining? — Waiting for two signals
A single signal may only lead to a temporary rebound; a combination of both signals will trigger a reversal:
1. Profit margin recovery:
- Domestically: More than three companies with annual sales under 100,000 units should be cleared out (停产/restructuring), or leading companies should stop cutting prices (terminal discounts < 15%).
- Overseas: Annual sales should exceed 500,000 units with a profit per vehicle higher than domestic levels, or they should rank in the top five in EU/ASEAN markets.
- Logic: With reduced supply, surviving companies can raise prices, improve profits, and FCF will turn positive.
2. Establishment of software licensing rights:
- For example, if the subscription rate for advanced driving features exceeds 8% with a retention rate of over 75%, or if software revenue accounts for more than 3% of total sales.
- Logic: As cars shift from being sold as hardware to providing ongoing software services, valuations will rise from manufacturing-based (8-12x PE) to a hybrid model including both hardware and software (25-40x PE for software).
Both of these signals are not yet clear, so the automotive stock market remains in a "chaotic" phase. However, companies that can sustain their operations will be the first to emerge from the downturn.
Conclusion
The investor who invested all their funds in BYD made a mistake not in choosing the wrong company but in using the wrong metric for valuation: in 2021, focus was on sales; in 2026, it's about cash flow. The automotive industry is transitioning from a "juvenile" phase of expansion to an "adult" phase focused on profit discipline. The excitement around sales and stories will eventually subside, and only companies with solid cash flows will withstand the test of time. There's no need to be too pessimistic—companies that can generate stable profits will emerge once the noise subsides.
(Note: Data in this article is as of June 2026 and does not constitute investment advice.)