<PAGE> 1
[VANGUARD EXPLORER FUND LOGO]
ANNUAL REPORT 1995
<PAGE> 2
In this Annual Report, I am delighted to formally introduce you to John J.
Brennan, who, on January 31, 1996, will assume my responsibilities as Chief
Executive Officer of Vanguard Explorer Fund and the other Funds in The Vanguard
Group. Mr. Brennan will continue to serve as President of the Funds, and I will
continue to serve as Chairman of the Board.
As a shareholder of the Fund for more than a quarter century and as
Chairman of all the Vanguard Funds, I want to tell you that I am enthusiastic
and conPdent that Jack Brennan is exactly the right person to succeed me as
Chief Executive Officer. To use yet another Vanguard nautical metaphor, he will
be the new captain. He has the qualities of leadership, integrity,
intelligence, and vision that must continue to be Vanguard's hallmark as we
move toward, and then into, the 21st century.
I know that he has these qualities, because Jack Brennan and I have been
working closely together since he joined Vanguard in 1982. He is a graduate of
Dartmouth College and Harvard Business School. He started as Assistant to the
Chairman and, rising like a rocket, became President in 1989. While, at age 41,
he may seem young, he is in fact older than I was when I became Chief Executive
Officer of Vanguard's predecessor organization in 1967, at the age of 38. Most
important of all, Jack is completely dedicated to the Vanguard character, and
believes in our basic mission: serving solely the shareholder, free of any
conflict of interest. He believes in holding our costs of operation to a
minimum, and in retaining our position as the lowest-cost provider of Financial
services in the world. He is a true competitor, who shares Vanguard's
dedication to providing highly competitive returns to our investors relative to
the returns provided by other mutual funds with comparable objectives. He also
believes in reporting our results to shareholders with complete candor. He has
the full support of the Board of Directors and our crew, and is committed to
staying the course we have set for Vanguard. You need have no doubt that the
essential elements that drew you to Vanguard in the Prst place will remain
intact.
[FIGURE 1]
As for me, I expect to fill a useful, if less demanding, role as Chairman
of the Board. I shall keep a watchful eye over the interests of our
shareholders, our crew, and our investment policies. I shall also speak out on
industry affairs, reminding all who will listen of the primacy of the interests
of mutual fund shareholders. I will be readily available to provide Jack
Brennan with whatever wisdom I may have acquired during my lifetime of
experience in this wonderful industry and in my service as captain of Vanguard
since I founded this unique organization more than two decades ago.
In short, I'll still be around. Thank you for all your confidence in me in
the past and, in advance, for your continued confidence in Vanguard under Jack
Brennan's leadership.
/s/ JOHN C. BOGLE
- -----------------
John C. Bogle
VANGUARD EXPLORER FUND SEEKS TO PROVIDE LONG-TERM CAPITAL APPRECIATION BY
INVESTING IN THE COMMON STOCKS OF RELATIVELY SMALL, UNSEASONED OR EMBRYONIC
COMPANIES. STOCKS ARE SELECTED PRINCIPALLY FOR THEIR LONG-TERM CAPITAL GROWTH
POTENTIAL; CURRENT INCOME AND SHORT-TERM MARKET FLUCTUATIONS ARE NOT
CONSIDERATIONS IN THE SELECTION OF INVESTMENTS.
<PAGE> 3
CHAIRMAN'S LETTER
FELLOW SHAREHOLDER:
During Explorer Fund's 1995 fiscal year, which ended on October 31, investors
enjoyed one of the strongest bull markets in history. The upsurge was led by
blue-chip stocks, but small-cap stocks--our stock in trade, as it were--turned
in solid, if less spectacular, gains.
Our Fund provided a total return (capital change plus income) of +17.5%,
just a bit short of the gain of +18.3% for the unmanaged Russell 2000
(small-capitalization stock) Index, our basic comparative standard. The return
of +26.4% for the unmanaged Standard & Poor's 500 Composite Stock Price
Index--dominated by the blue-chip stocks--presents a good indication of the
dichotomy between large and small stocks during the year. Our customary total
return table follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------
TOTAL RETURN
-----------------
FISCAL YEAR ENDED
OCTOBER 31, 1995
- ----------------------------------------------------------------
<S> <C>
VANGUARD EXPLORER FUND +17.5%
- ----------------------------------------------------------------
RUSSELL 2000 INDEX +18.3%
- ----------------------------------------------------------------
</TABLE>
The Fund's return is based on net asset values of $45.99 per share on October
31, 1994, and $51.05 on October 31, 1995, with the latter figure adjusted for
the reinvestment of an annual dividend of $.17 per share from net investment
income and a distribution of $2.26 from net realized capital gains. The Fund
realized additional capital gains (presently estimated at $4.03 per share)
during 1995 and will distribute them to shareholders in December, along with
this year's dividend distribution.
THE FISCAL YEAR IN REVIEW
The great bull market in stocks during our fiscal year began in mid-December
1994 and has continued quite dramatically since then. The pace of this gain was
virtually uninterrupted, and the dimension, if not unprecedented, was
extraordinary, delighting the bulls even as it astonished the bears.
There were, as always, many opinions as to the source of the surprising
strength in the stock market. In my view, it resulted from a combination of:
(1) record-breaking corporate profits; (2) a sharp decline in long-term
interest rates, with the yield on the long-term U.S. Treasury bond falling from
8.1% to 6.2%, engendering a +26% price increase; (3) the diminishing threat of
additional increases in short-term interest rates by the Federal Reserve Board;
(4) a slight softening in U.S. economic growth, resulting in continued optimism
about the outlook for inflation; and (5) a hint of speculative fever in the
equity marketplace.
The rise in corporate profits was particularly striking. It is estimated
that operating earnings for the companies in the Standard & Poor's 500 Index
will increase about +15% in 1995, after already rising +16% during 1994. (The
long-term annual increase in earnings since 1926 has averaged less than +7% per
year.) If there is a cautionary signal in this boom in profits, it is that the
two-year cumulative earnings growth of +33% has been accompanied by dividend
growth of only 11%. The result of this subdued dividend growth in the face of
sharply higher stock prices was a decline in the yield on the Index to 2.3%,
the lowest level on record. As we enter our 1996 fiscal year, this is surely a
sobering statistic.
While fiscal 1995, just as 1994, was a year of large-cap stock leadership,
it provided a marked contrast to the impressive dominance of small-cap stocks
during the prior three fiscal years. In the earlier period, the annualized
total return on the Russell 2000 Index was +32.0%, leagues above the +19.0%
return of the Standard & Poor's 500 Index. For the past two years, however, the
score was: 500 Index +14.6% per year; 2000 Index +8.6%. For the full five
years (fiscal 1991-1995), small stocks provided an average annual rate of
return of +22.1%, compared with +17.2% for large stocks--a meaningful
difference, albeit for a brief span of years.
The chart on page 2 provides the cumulative returns for large-cap and
small-cap stocks for the full five years. While small stocks led during this
particular period, I think that it would be inappropriate to draw any
particular conclusions from this chart. The fact is that, simply put, large-cap
1
<PAGE> 4
[FIGURE 2]
stocks have quite different risk and performance characteristics than small-cap
stocks. It is generally accepted--and hardly counter-intuitive--that small
companies carry higher interim risk and the opportunity for higher long-term
return. What is much less widely recognized is that this opportunity occurs
spasmodically rather than consistently. For example, small-cap stocks trailed
large-cap stocks from 1946-1958, from 1969-1973, and from 1983-1991. Too few
investors, in my experience, have the patience to wait out these "dry spells."
Given these patterns of the past, I would urge you to maintain your
small-cap stock position at whatever portion of your total portfolio you deem
appropriate, recognizing that, along with their potential for above-average
long-term growth, small stocks carry lower yields and higher risks. Guessing
about whether small-cap stocks or large-cap stocks will provide market
dominance during any particular year is, if you will forgive my candor, "a
fool's game."
EXPLORER FUND IN FISCAL 1995
Our +17.5% return for the past year was just 0.8 percentage points shy of the
+18.3% return on the Russell 2000 Index. Such a tiny margin is hardly worth
describing (whether the Fund holds the edge or not), but I should note two
particular factors that pretty much offset one another.
To begin, we held a large position in the technology group (27% of
Explorer's assets versus 18% for the Russell 2000 Index), which was a major
plus. However, our portfolio managers' poor selection of individual technology
stocks was an offsetting negative. On the other hand, our advisers' ability to
select the best-performing financial stocks was extraordinary, although this
advantage was partially offset by our substantial underweighting--6% of
Explorer's assets versus 22% for the Index--in this strong-performing sector.
You will note that the weightings of financial stocks and technology stocks are
about equal in the Index. This may seem surprising, but only until we point out
that the Index includes both growth stocks and value stocks.
Explorer's return for the year was a further distance behind the +22.7%
gain of the average small-cap mutual fund. The principal reason for this
shortfall is that most such funds place a greater emphasis on growth stocks
than on value stocks, while both Explorer and the Russell 2000 Index have
significant weightings in stocks of both types. During the past year, small
growth stocks held sway over small value stocks by a substantial margin.
Stocks of many small technology companies soared almost to the stratosphere,
and the group provided a stunning return of +43% during our fiscal year.
Given this dichotomy, mutual funds that maintained extra-large technology
positions (in many cases, 40% to 50% of assets, or even more) turned in truly
outstanding performance figures. Perhaps surprisingly, Explorer's 27% weighting
in the group exceeded the average 25% holdings of our small-cap peers. However,
as noted above, the individual technology selections of our portfolio managers
were less than satisfactory, as we pretty much missed the boom in
semi-conductor stocks.
In this context, I should note that the return achieved during the year by
Granahan Investment Management, Inc., one of our two advisers, outpaced the
Russell 2000 Index, while the return achieved by Wellington Management Company,
our original
2
<PAGE> 5
[FIGURE 3]
<TABLE>
<CAPTION>
Average Annual Total Returns--Periods Ended October 31, 1995
- ------------------------------------------------------------------------------
1 Year 5 Years 10 Years
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
VANGUARD EXPLORER FUND +17.46% +22.79% +10.75%
AVERAGE SMALL-CAP FUND +22.72 +22.63 +14.31
RUSSELL 2000 INDEX +18.33 +22.08 +11.82
</TABLE>
Note: Past performance is not predictive of future performance.
adviser, fell short. Each adviser is responsible for the supervision of about
one-half of our equity base, as shown in this table:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
TOTAL NET ASSETS
------------------------
MILLIONS PERCENTAGE
- ------------------------------------------------------------------
<S> <C> <C>
WELLINGTON
MANAGEMENT COMPANY $657 44%
GRANAHAN
INVESTMENT MANAGEMENT, INC. 633 43
CASH RESERVES 186 13
- ------------------------------------------------------------------
TOTAL $1,476 100%
- ------------------------------------------------------------------
</TABLE>
Your Officers and Directors periodically review the proportions of the Fund
supervised by each adviser. The most recent change occurred in early 1994, when
the Directors approved increasing the percentage of equity assets managed by
the Granahan firm from 40% to 50% of equities. We mentioned to you when our
multi-manager strategy was adopted in 1990 that we did not believe in "making
radical changes in policies or precipitate changes in advisers." While that
view remains intact today, we are considering a limited reallocation to
Granahan Investment Management, Inc. in 1996.
THE DECADE IN REVIEW
The Fund's average annual total return for the past ten years is presented in
the chart above. However, I would now like to present a record that, while of
shorter duration, may well be more relevant. Rather than beginning ten years
ago on October 31, 1985, this period begins on February 28, 1990. Then, our
multi-manager approach to small-cap investing was initiated with the addition
of Granahan Investment Management, Inc.
Veteran Explorer shareholders may recall that the Fund provided a rather
shabby performance during the last half of the 1980s. As we acknowledged in our
1989 Annual Report, past returns "would have to be characterized as
disappointing . . . Given this background, your Officers and Directors have
carefully evaluated the Fund's performance both on a short-term and a long-term
basis . . . concluding that some substantive modifications should be made in
3
<PAGE> 6
the Fund's policies and in its portfolio management." That said, we also
stated: "we are optimistic that, commensurate with its above-average risks, the
Fund will provide above-average returns during the coming decade."
While "the coming decade" is not yet six years complete, we believe that
our record thus far has justified that spirit of optimism. Our comparative
returns over the past six years relative to both the Russell 2000 Index and our
peer group of small-cap mutual funds have jumped from "poor" to "above
average." It has been the performance turned in by Granahan, the adviser we
added in 1990, that has been largely responsible for this improvement relative
to both our peer group and the 2000 Index. This table presents the Fund's
average annual return and the cumulative wealth that would have been earned on
an initial investment of $10,000, nearly six years ago:
<TABLE>
<CAPTION>
- --------------------------------------------------------------
TOTAL RETURN
------------------------------
FEBRUARY 28, 1990, TO
OCTOBER 31, 1995
------------------------------
FINAL VALUE
AVERAGE OF INITIAL
ANNUAL INVESTMENT
RATE OF $10,000
- --------------------------------------------------------------
<S> <C> <C>
VANGUARD EXPLORER FUND +16.2% $23,442
- --------------------------------------------------------------
AVERAGE SMALL-CAP FUND +16.0% $23,215
RUSSELL 2000 INDEX +13.7 20,740
- --------------------------------------------------------------
</TABLE>
This was, of course, a fine period for the overall stock market, for small-cap
stocks, for most of our peers, and, of course, even finer for Explorer Fund.
Future returns may be better or worse, but you should know that during
1990-1995, each of these standards earned returns that exceeded their long-term
norms. But, whatever the future holds, our decision to undertake a
multi-manager approach early in 1990--whether by luck or skill, naivete or
experience, stubbornness or conviction--reversed a period of poor relative
performance and has ushered in a period of significant improvement.
IN SUMMARY
Explorer Fund's basic objectives and strategies remain intact. We remain
committed to small-cap stocks as our long-term focus, investing in a broadly
diversified portfolio that may include equities with growth characteristics,
value characteristics, or some of each. We expect that this commitment will
provide us with enhanced long-term returns, even as we recognize, and freely
acknowledge, that it will give us above-average variability--greater risk, if
you will--from one year to the next, relative to the total stock market. While
that variability appeared on the negative side of the ledger in 1995, I'm sure
that many entries on the positive side will be posted in the years ahead.
That said, let me be clear that no mutual fund can eliminate the risks of
participation in the financial markets today. Indeed, as I noted earlier, given
the relatively high returns of stocks that we have had the good fortune to
enjoy during the past decade, the risks of investing have evidently increased.
Yet, perhaps the biggest long-term risks are: (1) failing to invest in the
financial markets at all; and (2) following an erratic and ever-changing
course. In my Annual Report a year ago, I urged you, rather, to "stay the
course," maintaining your Explorer Fund investment as the small-capitalization
component of a balanced portfolio of stock funds, bond funds, and money market
funds suitable to your own objectives. It proved wise counsel then; I reiterate
it today.
Sincerely,
/s/ JOHN C. BOGLE
- ------------------
John C. Bogle
Chairman of the Board
November 8, 1995
Note: Mutual fund data from Lipper Analytical Services, Inc.
4
<PAGE> 7
AVERAGE ANNUAL TOTAL RETURNS
THE AVERAGE ANNUAL TOTAL RETURNS FOR THE FUND (PERIODS ENDED SEPTEMBER 30,
1995) ARE AS FOLLOWS:
<TABLE>
<CAPTION>
10 YEARS
------------------------------------
INCEPTION TOTAL CAPITAL INCOME
DATE 1 YEAR 5 YEARS RETURN RETURN RETURN
---- ------ ------- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
VANGUARD EXPLORER FUND 12/11/67 +22.57% +22.84% +11.41% +10.65% +0.76%
</TABLE>
ALL OF THESE DATA REPRESENT PAST PERFORMANCE. THE INVESTMENT RETURN AND
PRINCIPAL VALUE OF AN INVESTMENT WILL FLUCTUATE SO THAT INVESTORS' SHARES, WHEN
REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST.
5
<PAGE> 8
TOTAL INVESTMENT RETURN TABLE
The following table illustrates the results of a single-share investment in
Vanguard Explorer Fund for the 25-year period ended October 31, 1995. During
the period illustrated, stock prices fluctuated widely; these results should
not be considered a representation of the dividend income or capital gain or
loss that may be realized from an investment made in the Fund today.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
PERIOD PER SHARE DATA* TOTAL INVESTMENT RETURN**
- ---------------------------------------------------------------------------------------------------------------------------------
Explorer Fund Russell 2000+
Value with Income -------------------------------- -------------
October 31 Net Asset Capital Gains Income Dividends & Capital Capital Income Total Total
Fiscal Year Value Distributions Dividends Gains Reinvested Return Return Return Return
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1971 $ 9.98 -- $.23 $ 10.25 +10.8% +3.0% +13.8% +16.8%
- ---------------------------------------------------------------------------------------------------------------------------------
1972 13.46 -- .09 13.96 +34.9 +1.3 +36.2 +21.9
- ---------------------------------------------------------------------------------------------------------------------------------
1973 11.91 -- -- 12.35 -11.5 0.0 -11.5 0.0
- ---------------------------------------------------------------------------------------------------------------------------------
1974 7.19 -- .14 7.57 -39.6 +0.9 -38.7 -28.7
- ---------------------------------------------------------------------------------------------------------------------------------
1975 8.13 -- .13 8.72 +13.1 +2.1 +15.2 +25.9
- ---------------------------------------------------------------------------------------------------------------------------------
1976 8.35 -- .05 9.02 + 2.8 +0.7 + 3.5 +20.1
- ---------------------------------------------------------------------------------------------------------------------------------
1977 9.77 -- .06 10.63 +17.0 +0.8 +17.8 - 6.1
- ---------------------------------------------------------------------------------------------------------------------------------
1978 12.32 -- .02 13.41 +26.0 +0.1 +26.1 + 6.3
- ---------------------------------------------------------------------------------------------------------------------------------
1979 16.09 -- .20 17.77 +30.6 +1.9 +32.5 +15.3
- ---------------------------------------------------------------------------------------------------------------------------------
1980 25.86 -- .24 28.96 +60.7 +2.3 +63.0 +55.3
- ---------------------------------------------------------------------------------------------------------------------------------
1981 28.05 -- .30 31.75 + 8.5 +1.1 + 9.6 + 4.1
- ---------------------------------------------------------------------------------------------------------------------------------
1982 28.91 $4.01 .50 38.95 +20.5 +2.2 +22.7 +14.8
- ---------------------------------------------------------------------------------------------------------------------------------
1983 38.35 .58 .24 53.05 +35.2 +1.0 +36.2 +38.3
- ---------------------------------------------------------------------------------------------------------------------------------
1984 31.10 1.66 .64 45.70 -15.3 +1.4 -13.9 - 3.2
- ---------------------------------------------------------------------------------------------------------------------------------
1985 32.56 .20 .38 48.79 + 5.4 +1.4 + 6.8 +15.8
- ---------------------------------------------------------------------------------------------------------------------------------
1986 31.59 1.29 .33 49.76 + 1.0 +1.0 + 2.0 +22.2
- ---------------------------------------------------------------------------------------------------------------------------------
1987 25.06 3.27 .02 44.08 -11.5 +0.1 -11.4 -13.6
- ---------------------------------------------------------------------------------------------------------------------------------
1988 29.64 1.96 .11 56.74 +28.2 +0.5 +28.7 +27.1
- ---------------------------------------------------------------------------------------------------------------------------------
1989 30.76 1.59 .32 62.95 + 9.8 +1.2 +11.0 +15.6
- ---------------------------------------------------------------------------------------------------------------------------------
1990 22.62 1.01 .37 48.52 -23.9 +1.0 -22.9 -27.3
- ---------------------------------------------------------------------------------------------------------------------------------
1991 36.75 -- .34 79.89 +62.5 +2.1 +64.6 +58.6
- ---------------------------------------------------------------------------------------------------------------------------------
1992 41.23 -- .26 90.24 +12.2 +0.8 +13.0 + 9.5
- ---------------------------------------------------------------------------------------------------------------------------------
1993 49.37 .78 .13 110.34 +21.9 +0.4 +22.3 +32.4
- ---------------------------------------------------------------------------------------------------------------------------------
1994 45.99 5.17 .14 115.29 + 4.2 +0.3 + 4.5 - 0.3
- ---------------------------------------------------------------------------------------------------------------------------------
1995 51.05 2.26 .17 135.44 +17.0 +0.5 +17.5 +18.3
- ---------------------------------------------------------------------------------------------------------------------------------
CUMULATIVE TOTAL +1,403.2% +1,454.4%
- ---------------------------------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURN +11.5% +11.6%
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Adjusted for 2-for-1 stock split, December 2, 1978.
** Includes reinvestment of income dividends and any capital gains
distributions for both the Fund and the Index.
+ Standard & Poor's 500 Index through 1979; Russell 2000 Index thereafter.
Note: The initial net asset value was $9.01 on October 31, 1970, the beginning
of the period illustrated. No adjustment has been made for income taxes payable
by shareholders on reinvested income dividends and capital gains distributions.
6
<PAGE> 9
REPORT FROM WELLINGTON MANAGEMENT COMPANY
The second half of fiscal 1995 was a strong one for the stock markets. The
domestic economy has continued on its steady growth path. Inflation and
interest rates are both subdued, and U.S. industry continues to post strong
earnings progress. This environment has been a healthy one for the stock
markets, and the Explorer Fund and the Russell 2000 Index posted double-digit
gains for the second half of the fiscal year.
There are, however, mixed signals in the economy today. Consumer spending
seems to be lower than warranted if the economy is still in its growth mode. We
are paying close attention to climbing inventories of goods and services and
the slowdown in the manufacturing sector. We expect that foreign currency will
not be strong going forward as the U.S. dollar starts to recover. We are
cautiously optimistic that the economy can continue to grow, but we are no
longer as convinced, as evidence continues to come in mixed. Both a balanced
budget and a capital gains tax cut are measures that we think the market would
warmly embrace. A capital gains tax cut would be particularly good for the
small companies in which we invest.
The companies in our portfolio continue to report good earnings progress.
Technology stocks continue to lead the market, but the fervor with which we see
some stocks being embraced makes us uncomfortable. The favorite few are
becoming the favorite fewer as the list begins to narrow. Some of these
technology stocks, particularly the "Internet" stocks, have reached valuation
levels that we find alarming. Both good news and bad news from companies seem
to be met with amplified reactions, with stock price performance going sharply
up or down respectively. The market has been characterized by extreme inter-day
and inter-week volatility.
Virtually all sectors were strong in the market. Our technology weighting
has not changed much, but we have rotated many of our holdings away from the
strongest momentum stories and into the steadier growers, where we are finding
friendlier valuations. This has resulted in a continued shift from the hardware
to the software names.
We continue to find good value in the consumer sector. Some of our initial
investments in this area may seem early, in retrospect, as consumers continue
to husband their dollars, but we are increasing our weightings into what we
think are terrific franchises. We've added dominant retailers such as General
Nutrition, Gymboree, and Discount Auto Parts to the portfolio.
We have taken lots of profits and reduced our commitment to the financial
services sector, probably our most successful sector, as both strongly
increasing profits and lower interest rates have resulted in powerful stock
price appreciation. We have used this cash to establish a position in the
energy services area. Here we are finding much better capitalized and more
dominant players, who are using their technology to help the major energy
companies lower finding and recovery costs. Efficient technology-oriented
companies, such as Falcon Drilling Company, Noble Drilling Company, and
Tidewater are a few of the names we have added in this area.
We are duly aware of the increasing volatility that is an important part
of our small company market fabric. Stock selection is more essential than ever
as disappointing news is causing extreme price volatility on the down-side.
Nevertheless, we are finding no shortage of interesting opportunities for
Explorer shareholders, and we continue to be very bullish about the prospects
for the long-term appreciation of the stocks in the portfolio. As always, we
remain focused on delivering superior long-term return for our shareholders.
Respectfully,
Kenneth L. Abrams, Senior Vice President
Portfolio Manager
Wellington Management Company
November 13, 1995
7
<PAGE> 10
REPORT FROM GRANAHAN INVESTMENT MANAGEMENT, INC.
After a slow start in the early part of our 1995 fiscal year, small company
stocks generally headed higher for the balance of the year. For the twelve
months ended October 31, 1995, the total return of the Russell 2000 Index of
small-capitalization stocks was +18.3% (see the Chairman's letter for details).
As opposed to a year ago, when interest rates were in their final phase of
an uptrend and earnings gains were strong and accelerating, we now have almost
the reverse as interest rates have moved down during most of 1995 and the very
strong earnings gains seen earlier in the year are now beginning to moderate.
We have noted in the past that declining interest rates are often beneficial
for stocks and 1995 has proved no exception.
PORTFOLIO COMMENTS
We saw particularly strong performance in the software and medical sectors,
which together represent about 22% of our portfolio. This included several
stocks that rose by more than 100% during the fiscal year such as Atria
Software (software designer tools), Integrated Silicon Systems (circuit
analyzing tools, and now being acquired), Genzyme Corp. Tissue Repair (skin and
tissue implant materials), and Target Therapeutics (micro-catheters for brain
and other minimally invasive surgery). Other important contributors to
performance included Cordis (cardiovascular devices, and soon to be acquired by
Johnson & Johnson), BMC (TV aperture masks and polycarbonate lenses), and The
Quick & Reilly Group (brokerage firm). All but one of these companies had very
strong earnings trends during the year.
The biggest penalties to performance included Best Buy (consumer
electronic chain), a recent new position where so far we have been too early
buying into an out-of-favor area, American Power Conversion (PC back-up power
units), which we have eliminated, and Wabash National (innovative intermodal
trailers), where we are maintaining our position.
Overall, we continue to see strong earnings growth for our portfolio's
companies, though more at historical levels of 25% as opposed to the 40% gains
we were seeing in 1994. In the latest reported twelve months, fully 82% of our
companies showed earnings growth, which is toward the high end of the range
historically.
Selection of companies with superior earnings growth potential is critical
to our investment process. Companies with managements that can either create
markets or exploit existing market opportunities offer such superior earnings
potential. The former, which we call "Pioneers," include such holdings as
Input/Output in 3-D seismic equipment, Mapinfo in desk-top mapping software,
Bio-Vascular in bovine processed tissue for pulmonary uses and 3D Systems Corp.
in stereo lithography for rapid prototype manufacturing.
Companies that are benefiting by exploiting traditional industry
inefficiencies through innovation also offer high earnings growth potential.
Some examples in our portfolio are as follows:
Itron has been a supplier of hand held electronic meter reading systems
and more recently remote automated meter reading systems that are designed for
real time data monitoring either by utility companies or by Itron. Utilities
see a fully automated fixed network system as offering them the ability to
lower operating costs, raise service quality, and position themselves to offer
new services, all critical in this era of potential deregulation for the
utility industry.
Manufactured housing as an industry continues to gain increasing share of
the new housing market, as its traditional advantage of low cost is being
combined with the manufacturers' growing capability to offer higher quality
products and easier financing. Southern Energy Homes, as a vertically
integrated producer of modular homes, has benefited from this increased
penetration domestically. Now they see the opportunity to test certain foreign
markets where similar advantages could be exploited; they will begin shipping
product into Germany in the near future.
While the airline industry seems to compete on the basis of periodic fare
wars and reduced service, Midwest Express Holdings operates a single class,
premium service, and premium fare airline catering primarily to business
travelers in selected business markets. Formerly a captive airline,
8
<PAGE> 11
Midwest is expanding its markets through a strategy of wider seats, superior
meals, and service-oriented employees for which it realizes premium yields,
high profitability, and solid revenue growth.
OUTLOOK
Our portfolio is positioned in companies with superior earnings growth
prospects. While we have made some commitments in out-of-favor areas like
consumer retailing and gaming stocks (Special Situations), our major
investments are in companies that offer good secular growth potential either
already demonstrated (Core Growers) or more speculative (Pioneers).
As noted above, we currently are seeing some cooling off from the very
high earnings comparisons of last year. Nevertheless, our companies continue to
deliver solid earnings gains overall; if our forecasts are right for next year,
earnings for our portfolio companies should be up over 25%. If achieved, this
should compare favorably to corporate profit trends in general.
As for valuation, the P/E (price/earnings) on latest 12 months earnings
for our companies is up a little to 22, but still in the midpoint of our
historical range of 30 plus for the high end to 14 at the low end.
Respectfully,
John J. Granahan, President
Granahan Investment Management, Inc.
November 10, 1995
9
<PAGE> 12
STATEMENT OF NET ASSETS
FINANCIAL STATEMENTS
October 31, 1995
<TABLE>
<CAPTION>
Market
Value
Shares (000)+
- ----------------------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (87.1%)
- ----------------------------------------------------------------------
BASIC MATERIALS (1.7%)
Commonwealth Aluminum Corp. 76,100 $ 1,208
J & L Specialty Steel Inc. 242,400 3,969
* Liposome Co., Inc. 300,000 4,538
* Lydall, Inc. 512,700 11,664
Quaker Chemical Corp. 155,000 2,325
* Zoltek Cos., Inc. 69,750 1,081
--------------
GROUP TOTAL 24,785
--------------
- ----------------------------------------------------------------------
CAPITAL GOODS & CONSTRUCTION (5.2%)
* Acmat Corp. Class A 143,000 1,644
* American Buildings Co. 224,000 5,600
* American Homestar Corp. 210,000 3,281
* Brooks Automation, Inc. 292,000 5,256
* Catalytica, Inc. 250,000 1,125
* The Cherry Corp. Class A 354,500 4,431
Elcor Corp. 210,700 4,425
* Envirosource, Inc. 859,000 2,255
* Newpark Resources, Inc. 130,000 2,064
Oakwood Homes Corp. 191,900 7,196
Pacific Scientific Co. 315,000 6,654
* Palm Harbor Homes, Inc. 147,000 2,683
* Redman Industries, Inc. 250,000 6,500
* Rohr, Inc. 200,000 2,975
* Southern Energy Homes, Inc. 460,000 6,613
* Tetra Technologies, Inc. 320,000 4,160
Valmont Industries, Inc. 428,000 10,219
--------------
GROUP TOTAL 77,081
--------------
- ----------------------------------------------------------------------
CONSUMER CYCLICAL (19.1%)
* Acclaim Entertainment Inc. 120,000 2,835
* Airsensors Inc. 173,800 1,455
* Anchor Gaming 369,000 8,118
Autocam Corp. 196,635 2,310
* Best Buy, Inc. 564,500 11,713
* Borg-Warner Security Corp. 1,000,000 10,375
* Broderbund Software, Inc. 50,000 3,462
Callaway Golf Co. 100,000 1,637
* Catalina Marketing Corp. 237,500 11,994
* Catherines Stores 300,000 2,662
* Chicago Miniature Lamp, Inc. 246,000 4,305
Coachmen Industries, Inc. 322,200 5,437
Comcast UK Cable Partners Ltd. 150,000 1,931
* Custom Chrome 189,000 4,678
* Day Runner, Inc. 219,500 5,378
* Discount Auto Parts Inc. 150,000 4,012
* Egghead, Inc. 837,100 5,755
Ellett Brothers, Inc. 193,000 1,472
* Ethan Allen Interiors Inc. 200,000 3,950
* General Nutrition Cos., Inc. 400,000 9,800
* Good Guys, Inc. 711,500 7,293
* Gymboree Inc. 200,000 4,525
* Image Industries, Inc. 100,000 1,200
Intelligent Electronics Inc. 1,054,300 8,039
* International Family
Entertainment, Inc. Class B 370,790 6,860
*(1) Iwerks Entertainment, Inc. 547,200 2,736
* JPE, Inc. 179,000 2,058
* Learning Co. 54,000 3,186
Marcus Corp. 270,000 9,349
McGrath Rentcorp. 387,400 6,780
Mercantile Stores Co., Inc. 150,000 6,731
* Merisel, Inc. 1,300,000 7,638
* Musicland Stores Corp. 1,100,000 7,150
* National Auto Credit Co. 360,900 5,865
* Norton McNaughton, Inc. 300,000 5,925
* People's Choice TV Corp. 300,000 6,150
* Play By Play Toy & Novelties, Inc. 120,000 1,290
* Playboy Enterprises Inc. Class B 570,500 4,849
* Prime Hospitality Corp. 700,000 6,913
* Quality Dining, Inc. 190,500 3,691
* Renters Choice, Inc. 500,000 8,375
* Rex Stores Corp. 350,000 5,950
Rival Manufacturing Co. 214,200 4,177
S-K-I, Ltd. 59,550 759
E.W. Scripps Co. 114,000 4,304
Spartan Motors, Inc. 136,500 1,314
* Spectrum Holobyte 300,000 3,075
* Sports & Recreation 600,000 4,425
Sturm, Ruger & Co., Inc. 175,000 4,725
* Ultimate Electronics, Inc. 150,000 1,350
* Urban Outfitters, Inc. 300,000 6,525
VWR Scientific Products Corp. 343,400 4,464
* Valuevision International, Inc.
Class A 500,000 2,594
Wabash National Corp. 173,000 4,390
Warnaco Group 200,000 4,650
* Westcott Communications 500,000 6,875
Winnebago Industries, Inc. 337,000 2,696
--------------
GROUP TOTAL 282,155
--------------
- ----------------------------------------------------------------------
CONSUMER STAPLES (1.7%)
Bridgford Foods Corp. 194,700 1,898
* Canandaigua Wine Co., Inc.
Class A 130,000 6,208
* Celestial Seasonings, Inc. 200,000 3,400
* Hain Food Group, Inc. 334,500 1,045
* National Dentex Corp. 150,000 2,700
* Stokely USA, Inc. 224,800 1,405
* Sylvan, Inc. 200,000 2,125
* Whole Food Markets, Inc. 328,000 3,936
* Wholesome & Hearty Foods, Inc. 175,000 1,706
--------------
GROUP TOTAL 24,423
--------------
- ----------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
Market
Value
Shares (000)+
- ----------------------------------------------------------------------
<S> <C> <C>
ENERGY (1.6%)
* Falcon Drilling Co., Inc. 42,800 $ 428
* Hornbeck Offshore Services, Inc. 300,000 4,313
* Kirby Corp. 525,000 8,662
* Marine Drilling Co., Inc. 400,000 1,500
* Noble Drilling Corp. 800,000 5,600
Tidewater, Inc. 100,000 2,638
--------------
GROUP TOTAL 23,141
--------------
- ----------------------------------------------------------------------
FINANCIAL (6.4%)
Astoria Financial Corp. 150,000 6,431
Charter One Financial 130,000 3,673
* Dime Bancorp, Inc. 300,000 3,187
Fidelity National Financial, Inc. 498,315 7,911
* First Federal Financial 250,200 3,878
Green Point Financial Corp. 200,000 5,400
Inter-Regional Financial
Group, Inc. 315,600 11,086
Legg Mason Inc. 25,300 727
Long Island Bancorp, Inc. 252,600 5,747
Mercury Finance Co. 240,144 4,623
North American Mortgage 293,900 6,062
* Olympic Financial Ltd. 156,000 2,808
Peoples Bank of Bridgeport 150,000 2,963
* Physicians Health Services, Inc. 250,000 8,250
The Quick & Reilly Group, Inc. 258,375 6,136
* Resource Bancshares
Mortgage Group, Inc. 250,000 3,687
Standard Federal Bank 73,300 2,602
Sun Communities, Inc. 250,000 6,219
Westcorp, Inc. 200,000 3,350
--------------
GROUP TOTAL 94,740
--------------
- ----------------------------------------------------------------------
HEALTH CARE (17.5%)
* Advanced Magnetics, Inc. 193,900 5,235
* Alliance Pharmaceutical Corp. 600,000 7,125
Alpharma Inc. Class A 197,800 4,747
* Amylin Pharmaceuticals, Inc. 818,000 5,930
* Apria Healthcare 200,000 4,300
Arrow International, Inc. 141,500 5,908
* Athena Neurosciences, Inc. 466,000 4,369
* Autoimmune, Inc. 100,000 900
* Ballard Medical Products 200,000 3,450
* Beverly Enterprises Inc. 400,000 4,700
* Biomet, Inc. 200,000 3,325
* Bio-Rad Labs, Inc. Class A 186,000 7,068
* Bio-Vascular, Inc. 255,000 3,570
* Cell Genesys, Inc. 572,000 4,219
* Centocor, Inc. 373,000 4,150
* Charter Medical Corp. 600,000 10,800
Collagen Corp. 107,300 1,931
* Cordis Corp. 50,000 5,525
* Cytotherapeutics, Inc. 173,000 1,730
* Datascope Corp. 300,000 7,125
* FHP International Corp. 276,100 6,695
* FPA Medical Management, Inc. 111,800 936
* Gelman Sciences, Inc. 294,025 6,285
* Genesis Health Ventures Inc. 125,000 3,609
* Genetics Institute Inc.
Depository Shares 236,142 8,737
* Genzyme Corp. Tissue Repair 225,296 4,027
* Grancare Inc. 605,800 8,860
* Haemonetics Corp. 700,000 13,213
* Healthdyne Inc. 71,900 701
* Healthdyne Technologies, Inc. 288,286 3,099
* Idec Pharmaceuticals Corp. 236,900 2,754
* Immulogic Pharmaceutical Corp. 200,000 2,300
* Immunex Corp. 300,000 3,750
* Integra Lifesciences 233,381 1,634
* Isomedix, Inc. 108,300 1,462
Kinetic Concepts, Inc. 750,000 8,344
Life Technologies, Inc. 300,000 7,350
* Ligand Pharmaceuticals Class B 300,000 2,363
* Magainin Pharmaceuticals 400,000 3,250
* Martek Biosciences Corp. 110,000 2,090
Minntech Corp. 181,077 3,576
* Multicare Cos., Inc. 287,000 5,381
* Patterson Dental Co. 161,500 3,957
* Perrigo Co. 400,000 4,900
* Protein Design Labs 300,000 4,950
* Sofamor/Danek Group Inc. 347,300 8,509
Sullivan Dental Products, Inc. 294,500 2,871
* Sybron Corp. 160,000 6,800
* Systemed Inc. 720,000 4,410
* Target Therapeutics, Inc. 70,000 5,373
* Total Renal Care Holdings, Inc. 13,900 283
* Theratech, Inc. 325,000 5,931
* Univax Biologics, Inc. 377,500 2,383
* Vencor, Inc. 327,250 9,081
* Vertex Pharmaceuticals, Inc. 150,000 2,475
--------------
GROUP TOTAL 258,446
--------------
- ----------------------------------------------------------------------
TECHNOLOGY (27.2%)
* A+ Communications, Inc. 200,000 2,800
* Acres Gaming, Inc. 100,000 675
* Active Voice Corp. 209,000 5,486
* Acxiom Corp. 160,000 4,720
* American Telecasting, Inc. 355,000 4,792
* Applied Voice Technology, Inc. 332,000 3,735
* Atria Software, Inc. 288,000 10,296
BGS Systems, Inc. 155,000 5,658
* BISYS Group, Inc. 432,400 11,999
BMC Industries, Inc. 398,700 15,400
* BMC Software, Inc. 160,000 5,680
</TABLE>
11
<PAGE> 14
STATEMENT OF NET ASSETS (continued)
<TABLE>
<CAPTION>
Market
Value
Shares (000)+
- ----------------------------------------------------------------------
<S> <C> <C>
*(1) Bachman Information
Systems, Inc. 854,400 $ 4,806
*(1) Boole & Babbage Inc. 412,650 14,752
* Broadband Technologies, Inc. 110,000 1,925
* California Microwave, Inc. 125,000 2,688
* Centigram Communications 300,000 6,338
Charter Power Systems, Inc. 158,000 3,950
* Cheyenne Software, Inc. 500,000 10,438
* Cognos Inc. 210,000 6,694
* CompuCom Systems, Inc. 180,000 1,192
* Compuware Corp. 48,500 1,103
* Concord EFS, Inc. 100,000 3,425
*(1) Conductus, Inc. 292,300 1,900
* Cooper & Chyan Technology, Inc. 26,300 368
* CyCare Systems, Inc. 80,000 2,480
* Cyrix Corp. 220,000 7,012
* DH Technology, Inc. 158,150 3,123
Dallas Semiconductor Corp. 741,500 15,757
* Davidson and Associates, Inc. 235,000 8,342
* Dialogic Corp. 60,000 1,710
* Digital Biometrics, Inc. 163,500 1,001
* Digitran Systems, Inc. 185,700 93
*(1) Dionex Corp. 359,500 19,143
*(1) Encad, Inc. 315,000 4,725
* Exar Corp. 100,000 2,375
* Executone Information Systems 1,500,000 3,844
* Expert Software Inc. 160,000 3,240
* FLIR Systems, Inc. 230,000 2,818
* FTP Software, Inc. 300,000 8,100
* Gilat Satellite Networks Ltd. 229,000 5,095
* IFR Systems, Inc. 237,225 2,135
* Information Resources, Inc. 253,300 2,723
* Input/Output, Inc. 275,000 10,278
* Integrated Silicon Systems 140,000 4,060
* International Cabletel, Inc. 256,666 6,802
* Itron, Inc. 409,000 11,861
* MapInfo Corp. 236,000 4,720
* Maxis, Inc. 160,000 7,000
* Micrografx, Inc. 400,000 4,450
*(1) Natural Microsystems Corp. 250,000 6,187
* Netmanage, Inc. 200,000 4,075
* NetStar, Inc. 90,000 878
* Number Nine Visual
Technology Corp. 307,500 4,228
*(1) Peoples Telephone Co., Inc. 1,225,000 3,139
* Pinnacle Micro Inc. 50,000 1,300
* Planar Systems, Inc. 200,000 3,400
* Policy Management Systems Corp. 200,000 9,425
* Recoton Corp. 349,150 7,769
* SHL Systemhouse, Inc. 553,800 7,061
* Sequent Computer Systems, Inc. 400,000 6,950
* Softkey International, Inc. 61,900 1,950
* Sterling Electronics Corp. 294,600 5,266
* Sterling Software, Inc. 200,000 9,225
* Stratus Computer, Inc. 175,000 5,447
* SunGard Data Systems 580,000 15,950
* Symbol Technologies, Inc. 100,000 3,488
* Synopsys, Inc. 315,000 11,655
* Systemsoft Corp. 296,000 4,218
TSI, Inc. 138,750 1,613
* 3D Systems Corp. 200,000 3,400
* Zebra Technologies Class A 193,000 11,435
--------------
GROUP TOTAL 401,766
--------------
- ----------------------------------------------------------------------
TRANSPORT SERVICES (4.8%)
Air Express International Corp. 802,650 16,254
* America West Airlines, Inc. 300,000 4,088
American President Cos., Ltd. 34,900 846
* Boyd Brothers Transportation, Inc. 180,000 1,485
Expeditors International
of Washington, Inc. 292,000 7,665
Frozen Food Express
Industries, Inc. 361,282 3,206
* Heartland Express, Inc. 156,550 4,227
* M.S. Carriers Inc. 300,000 4,650
* Midwest Express Holdings, Inc. 250,000 6,281
Pittston Services Group 185,300 5,096
* RailTex, Inc. 340,200 6,889
* Swift Transportation Co., Inc. 400,000 6,600
* Trans World Airlines 553,900 4,154
--------------
GROUP TOTAL 71,441
--------------
- ----------------------------------------------------------------------
MISCELLANEOUS (1.9%)
* Asyst Technologies, Inc. 100,000 4,200
* Education Alternatives, Inc. 200,000 1,400
* NFO Research Inc. 281,000 6,112
* On Assignment, Inc. 163,000 4,279
*(1) Prepaid Legal Services, Inc. 1,076,900 8,548
Wackenhut Corp. Class B 199,900 2,773
--------------
GROUP TOTAL 27,312
--------------
- ----------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost $1,076,718) 1,285,290
- ----------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCK (.3%)
- ----------------------------------------------------------------------
AMC Entertainment $1.75
(Cost $3,257) 139,200 4,663
- ----------------------------------------------------------------------
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- ----------------------------------------------------------------------
<S> <C> <C>
TEMPORARY CASH INVESTMENT (13.0%)
- ----------------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account 5.89%, 11/1/95
(Cost $191,698) $ 191,698 $ 191,698
- ----------------------------------------------------------------------
TOTAL INVESTMENTS (100.4%)
(Cost $1,271,673) 1,481,651
- ----------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-.4%)
- ----------------------------------------------------------------------
Other Assets--Note C 29,861
Liabilities (35,552)
------------
(5,691)
- ----------------------------------------------------------------------
NET ASSETS (100%)
- ----------------------------------------------------------------------
Applicable to 28,909,468 outstanding
$.001 par value shares
(authorized 100,000,000 shares) $1,475,960
- ----------------------------------------------------------------------
NET ASSET VALUE PER SHARE $51.05
======================================================================
</TABLE>
+ See Note A to Financial Statements.
* Non-Income Producing Security.
(1) Considered an affiliated company as the Fund owns more than 5% of the
outstanding voting securities of such company.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
AT OCTOBER 31, 1995,
NET ASSETS CONSISTED OF:
- ----------------------------------------------------------------------
Amount Per
(000) Share
----------- -------
<S> <C> <C>
Paid in Capital $1,143,472 $39.55
Undistributed Net
Investment Income 5,269 .18
Accumulated Net Realized Gains 117,241 4.06
Unrealized Appreciation of
Investments--Note D 209,978 7.26
- ----------------------------------------------------------------------
NET ASSETS $1,475,960 $51.05
- ----------------------------------------------------------------------
</TABLE>
13
<PAGE> 16
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended
October 31, 1995
(000)
- -----------------------------------------------------------------------------------------
<S> <C> <C>
INVESTMENT INCOME
INCOME
Dividends . . . . . . . . . . . . . . . . . . . . . . . $ 5,173
Interest . . . . . . . . . . . . . . . . . . . . . . . . 10,129
- -----------------------------------------------------------------------------------------
Total Income . . . . . . . . . . . . . . . . . . . 15,302
- -----------------------------------------------------------------------------------------
EXPENSES
Investment Advisory Fees--Note B
Basic Fees . . . . . . . . . . . . . . . . . . . . . $3,497
Performance Adjustments . . . . . . . . . . . . . . 25 3,522
------
The Vanguard Group--Note C
Management and Administrative . . . . . . . . . . . . 4,586
Marketing and Distribution . . . . . . . . . . . . . 232 4,818
------
Taxes (other than income taxes) . . . . . . . . . . . . 110
Custodians' Fees . . . . . . . . . . . . . . . . . . . . 55
Auditing Fees . . . . . . . . . . . . . . . . . . . . . 10
Shareholders' Reports . . . . . . . . . . . . . . . . . 127
Annual Meeting and Proxy Costs . . . . . . . . . . . . . 32
Directors' Fees and Expenses . . . . . . . . . . . . . . 6
- -----------------------------------------------------------------------------------------
Total Expenses . . . . . . . . . . . . . . . . . . 8,680
- -----------------------------------------------------------------------------------------
Net Investment Income . . . . . . . . . . 6,622
- -----------------------------------------------------------------------------------------
REALIZED NET GAIN ON
INVESTMENT SECURITIES SOLD . . . . . . . . . . . . . . . . 117,328
- -----------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
OF INVESTMENT SECURITIES . . . . . . . . . . . . . . . . . 85,259
- -----------------------------------------------------------------------------------------
Net Increase in Net Assets
Resulting from Operations . . . . . . . $209,209
=========================================================================================
</TABLE>
14
<PAGE> 17
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED Year Ended
OCTOBER 31, 1995 October 31, 1994
(000) (000)
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income . . . . . . . . . . . . . . . . . . . . . . . $ 6,622 $ 3,670
Realized Net Gain . . . . . . . . . . . . . . . . . . . . . . . . . 117,328 55,617
Change in Unrealized Appreciation (Depreciation) . . . . . . . . . 85,259 (15,205)
- ----------------------------------------------------------------------------------------------------------------
Net Increase in Net Assets Resulting from Operations . . . . 209,209 44,082
- ----------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS (1)
Net Investment Income . . . . . . . . . . . . . . . . . . . . . . . (4,173) (2,310)
Realized Net Gain . . . . . . . . . . . . . . . . . . . . . . . . . (55,488) (85,303)
- ----------------------------------------------------------------------------------------------------------------
Total Distributions . . . . . . . . . . . . . . . . . . . . . (59,661) (87,613)
- ----------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (2)
Issued --Regular . . . . . . . . . . . . . . . . . . . . . . . . 231,633 123,565
--In Lieu of Cash Distributions . . . . . . . . . . . . . 58,533 85,931
--Exchange . . . . . . . . . . . . . . . . . . . . . . . . 180,074 183,170
--Exchange for Net Assets of Vanguard Specialized
Portfolios-Technology Portfolio--Note E . . . . . . . -- 75,241
Redeemed --Regular . . . . . . . . . . . . . . . . . . . . . . . . (92,642) (82,956)
--Exchange . . . . . . . . . . . . . . . . . . . . . . . . (163,513) (31,432)
- ----------------------------------------------------------------------------------------------------------------
Net Increase from
Capital Share Transactions . . . . . . . . . . . . . . . . 214,085 353,519
- ----------------------------------------------------------------------------------------------------------------
Total Increase . . . . . . . . . . . . . . . . . . . . . . . 363,633 309,988
- ----------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year . . . . . . . . . . . . . . . . . . . . . . . . . 1,112,327 802,339
- ----------------------------------------------------------------------------------------------------------------
End of Year (3) . . . . . . . . . . . . . . . . . . . . . . . . . . $1,475,960 $1,112,327
================================================================================================================
(1) Distributions Per Share
Net Investment Income . . . . . . . . . . . . . . . . . . . . $ .17 $ .14
Realized Net Gain . . . . . . . . . . . . . . . . . . . . . . $2.26 $5.17
- ----------------------------------------------------------------------------------------------------------------
(2) Shares Issued and Redeemed
Issued . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,774 6,824
Issued in Lieu of Cash Distributions . . . . . . . . . . . . 1,402 1,969
Issued in Exchange for Net Assets of Vanguard Specialized
Portfolios-Technology Portfolio--Note E . . . . . -- 1,697
Redeemed . . . . . . . . . . . . . . . . . . . . . . . . . . (5,452) (2,557)
- ----------------------------------------------------------------------------------------------------------------
4,724 7,933
- ----------------------------------------------------------------------------------------------------------------
(3) Undistributed Net Investment Income . . . . . . . . . . . . . $ 5,269 $ 2,820
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
15
<PAGE> 18
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Year Ended October 31,
-----------------------------------------------------------
For a Share Outstanding Throughout Each Year 1995 1994 1993 1992 1991
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR . . . . . . . . $45.99 $49.37 $41.23 $36.75 $22.62
------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income . . . . . . . . . . . . . .24 .16 .14 .15 .26
Net Realized and Unrealized Gain
on Investments . . . . . . . . . . . . . . . 7.25 1.77 8.91 4.59 14.21
-------- ------- ------- ------- -------
TOTAL FROM INVESTMENT OPERATIONS . . . . 7.49 1.93 9.05 4.74 14.47
- --------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income . . . . . (.17) (.14) (.13) (.26) (.34)
Distributions from Realized Capital Gains . . . (2.26) (5.17) (.78) -- --
-------- ------- ------- ------- -------
TOTAL DISTRIBUTIONS . . . . . . . . . . (2.43) (5.31) (.91) (.26) (.34)
- --------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR . . . . . . . . . . . $51.05 $45.99 $49.37 $41.23 $36.75
==========================================================================================================================
TOTAL RETURN . . . . . . . . . . . . . . . . . . . +17.46% +4.49% +22.28% +12.95% +64.64%
- --------------------------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
- ------------------------
Net Assets, End of Year (Millions) . . . . . . . . $1,476 $1,112 $802 $519 $381
Ratio of Expenses to Average Net Assets . . . . . . .68% .70% .73% .69% .56%
Ratio of Net Investment Income to
Average Net Assets . . . . . . . . . . . . . . .52% .39% .32% .38% .85%
Portfolio Turnover Rate . . . . . . . . . . . . . . 66% 82% 51% 43% 49%
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE> 19
NOTES TO FINANCIAL STATEMENTS
Vanguard Explorer Fund is registered under the Investment Company Act of 1940
as a diversified open-end investment company.
A. The following significant accounting policies are in conformity with
generally accepted accounting principles for investment companies. Such
policies are consistently followed by the Fund in the preparation of financial
statements.
1. SECURITY VALUATION: Securities listed on an exchange are valued at the
latest quoted sales prices as of the close of the New York Stock Exchange
(generally 4:00 PM) on the valuation date; securities not traded are valued
at the mean of the latest quoted bid and asked prices. Securities not listed
are valued at the latest quoted bid prices. Temporary cash investments are
valued at cost which approximates market value.
2. FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a regulated
investment company and distribute all of its taxable income. Accordingly, no
provision for Federal income taxes is required in the financial statements.
3. REPURCHASE AGREEMENTS: The Fund, along with other members of The Vanguard
Group of Investment Companies, transfers uninvested cash balances into a
Pooled Cash Account, the daily aggregate of which is invested in repurchase
agreements secured by U.S. Government obligations. Securities pledged as
collateral for repurchase agreements are held by a custodian bank until
maturity of each repurchase agreement. Provisions of each agreement require
that the market value of the collateral is sufficient in the event of
default; however, in the event of default or bankruptcy by the other party
to the agreement, realization and/or retention of the collateral may be
subject to legal proceedings.
4. OTHER: Security transactions are accounted for on the date the securities
are purchased or sold. Costs used in determining realized gains and losses
on the sale of investment securities are those of specific securities sold.
Dividend income and distributions to shareholders are recorded on the
ex-dividend date.
B. Under the terms of contracts which expire February 27, 1996, the Fund pays
Granahan Investment Management, Inc. and Wellington Management Company a basic
investment advisory fee calculated at an annual percentage rate of the average
net assets of the Fund. The basic fee thus computed is subject to quarterly
adjustments based on performance relative to the Russell 2000 Index. For the
year ended October 31, 1995, the aggregate investment advisory fee represented
an effective annual base rate of .27 of 1% of Fund average net assets before an
increase of $25,000 based on performance.
C. The Vanguard Group, Inc. furnishes at cost corporate management,
administrative, marketing, and distribution services. The costs of such
services are allocated to the Fund under methods approved by the Board of
Directors. At October 31, 1995, the Fund had contributed capital of $188,000 to
Vanguard (included in Other Assets), representing .9% of Vanguard's
capitalization. The Fund's directors and officers are also directors and
officers of Vanguard.
D. During the year ended October 31, 1995, the Fund made purchases of
$871,849,000 and sales of $741,292,000 of investment securities other than U.S.
Government securities and temporary cash investments.
At October 31, 1995, unrealized appreciation for financial reporting and
Federal income tax purposes aggregated $209,978,000, of which $287,403,000
related to appreciated securities and $77,425,000 related to depreciated
securities.
17
<PAGE> 20
NOTES TO FINANCIAL STATEMENTS (continued)
E. In accordance with the terms of an agreement approved by Vanguard
Specialized Portfolios--Technology Portfolio shareholders, on June 2, 1994,
Vanguard Explorer Fund issued 1,697,000 of its capital shares in exchange for
the net assets of Vanguard Specialized Portfolios--Technology Portfolio of
$75,241,000, including $1,491,000 of unrealized depreciation; combined net
assets were $1,038,199,000 as of the merger date. Shareholders of Vanguard
Specialized Portfolios--Technology Portfolio received .390 shares of Vanguard
Explorer Fund for each share of Vanguard Specialized Portfolios--Technology
Portfolio. The transaction, which was a tax-free exchange, has been accounted
for by combining the assets and liabilities of each Fund at their value on the
date of the merger. The identified cost of investments were similarly combined.
18
<PAGE> 21
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
Vanguard Explorer Fund
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Explorer Fund (the "Fund") at October 31, 1995, and the results of its
operations, the changes in its net assets and the financial highlights for each
of the respective periods presented, in conformity with generally accepted
accounting principles. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the responsibility of the
Fund's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities by correspondence with the custodian and brokers and
the application of alternative auditing procedures where confirmations from
brokers were not received, provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
November 30, 1995
SPECIAL 1995 TAX INFORMATION (UNAUDITED)
FOR VANGUARD EXPLORER FUND, INC.
Corporate shareholders should note that for the fiscal year ended October 31,
1995, 13.4% of the Fund's investment income (i.e., dividend income plus
short-term capital gains, if any) qualifies for the intercorporate dividends
received deduction.
19
<PAGE> 22
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman and Chief Executive Officer Chairman and Director of
The Vanguard Group, Inc., and of each of the investment companies in The
Vanguard Group.
JOHN J. BRENNAN, President
President and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, Chairman of Rhone-Poulenc Rorer Inc.; Director of Sun
Company, Inc.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea Co.,
Alco Standard Corp., Raytheon Co., Knight-Ridder, Inc., and Massachusetts
Mutual Life Insurance Co.
BRUCE K. MACLAURY, President of The Brookings Institution; Director of American
Express Bank Ltd. and The St. Paul Companies, Inc.
BURTON G. MALKIEL, Chemical Bank Chairman's Professor of Economics, Princeton
University; Director of Prudential Insurance Co. of America, Amdahl Corp.,
Baker Fentress & Co., The Jeffrey Co., and Southern New England Communications
Co.
ALFRED M. RANKIN, JR., Chairman, President, and Chief Executive Officer of
NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Co., and
The Standard Products Co.
JOHN C. SAWHILL, President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and
President of New York University; Director of Pacific Gas and Electric Co. and
NACCO Industries.
JAMES O. WELCH, JR., Retired Chairman of Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc. and Kmart
Corp.
J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas Co.;
Director of Cummins Engine Co.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY, Secretary; Senior Vice President and Secretary of The
Vanguard Group, Inc.; Secretary of each of the investment companies in The
Vanguard Group.
RICHARD F. HYLAND, Treasurer; Treasurer of The Vanguard Group, Inc., and of
each of the investment companies in The Vanguard Group.
KAREN E. WEST, Controller; Vice President of The Vanguard Group, Inc.;
Controller of each of the investment companies in The Vanguard Group.
OTHER VANGUARD GROUP OFFICERS
ROBERT A. DISTEFANO IAN A. MACKINNON
Senior Vice President Senior Vice President
Information Technology Fixed Income Group
JEREMY G. DUFFIELD F. WILLIAM MCNABB III
Senior Vice President Senior Vice President
Planning & Development Institutional
JAMES H. GATELY RALPH K. PACKARD
Senior Vice President Senior Vice President
Individual Investor Group Chief Financial Officer
20
<PAGE> 23
THE VANGUARD FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard/Trustees' Equity Fund
U.S. Portfolio
Vanguard Convertible
Securities Fund
BALANCED FUNDS
Vanguard/Wellington Fund
Vanguard/Wellesley Income Fund
Vanguard STAR Portfolio
Vanguard Asset Allocation Fund
Vanguard LIFEStrategy Funds
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
Vanguard Horizon Fund
Global Equity Portfolio
Global Asset Allocation Portfolio
Capital Opportunity Portfolio
Aggressive Growth Portfolio
INTERNATIONAL FUNDS
Vanguard International
Growth Portfolio
Vanguard/Trustees' Equity Fund
International Portfolio
INDEX FUNDS
Vanguard Index Trust
500 Portfolio
Total Stock Market Portfolio
Extended Market Portfolio
Growth Portfolio
Value Portfolio
Small Capitalization Stock Portfolio
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Total Bond Market Portfolio
Short-Term Bond Portfolio
Intermediate-Term Bond Portfolio
Long-Term Bond Portfolio
Vanguard International Equity
Index Fund
European Portfolio
Pacific Portfolio
Emerging Markets Portfolio
FIXED INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Money Market Reserves
Vanguard Admiral Fund
U.S. Treasury Money Market Portfolio
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Money Market Portfolio
Vanguard State Tax-Free Funds
Money Market Portfolios
(CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
Insured Longer-Term Portfolios
(CA, FL, NJ, NY, OH, PA)
INCOME FUNDS
Vanguard Fixed Income
Securities Fund
Vanguard Admiral Fund
Vanguard Preferred Stock Fund
[THE VANGUARD GROUP LOGO]
This Report has been prepared for shareholders and may be distributed to others
only if preceded or accompanied by a current prospectus. All Funds in the
Vanguard Family are offered by prospectus only.
Vanguard Financial Center
Valley Forge, Pennsylvania 19482
New Account Information:
1 (800) 662-7447
Shareholder Account Services:
1 (800) 662-2739
Q240-10/95
On Our Cover: On the evening of August 1, 1798, Lord Horatio Nelson sailed his
flagship, HMS Vanguard, into Egypt's Aboukir Bay. In a night encounter, the
British fleet decimated Napoleon Bonaparte's ships of the line in what is still
considered to be the most complete victory ever recorded in naval history. Our
Report's cover illustration is Thomas Luny's 1830 painting, The Battle Of The
Nile, in which the French flagship, L'Orient, is shown as it exploded at 10:00
p.m. under a gibbous moon.
<PAGE> 24
[BACK COVER]
<PAGE> 25
EXPLORER FUND
EDGAR APPENDIX
This appendix describes the components of the printed version of this report
that do not translate into a format acceptable to the EDGAR system.
The cover of the printed version of this report features Thomas Luny's 1830
painting "The Battle Of The Nile"
A photograph of John C. Brennan and John C. Bogle appears on the inside cover
top-center.
A running head featuring a sword, helmet, gloves and battleships in the
background appear at the top of pages one through four.
A line chart of the Indexed Value (Russell 2000 Index, and Standard & Poor's
500 Index) of Vanguard Explorer Fund for the fiscal years 1991 through 1995
appears at the upper left of page two.
Line charts illustrating cumulative performance between Vanguard Explorer Fund,
Average Small-Cap Fund and Russell 2000 Index, average Annual Total Returns for
the period October 31, 1985, to October 31, 1995 appear at the top of page
three.
A running head featuring a compass, hour glass and telescope, and battleships
in the background appears at the top of page five.
A running head featuring a cannon and battleships in the background appears at
the top of page six.
A running head featuring ships wheel, rope and battleships in the background
appears at the top of pages seven through nine.
A running head featuring open log book, pen and battleships in the background
appears at the top of pages ten through nineteen.
A running head featuring a sextant, a map, and battleships in the background
appears at the top of page twenty.
A running head featuring birds flying and ships in the background appears at
the top of the back cover.
