<PAGE> 1
VANGUARD/
PRIMECAP
FUND
Annual Report
December 31, 1996
THE VANGUARD GROUP: LINKING TRADITION AND INNOVATION
At Vanguard, we treasure our rich nautical heritage--even as we steer our
course toward the twenty-first century. Our Report cover reflects that blending
of tradition and innovation, of past, present, and future. The montage
includes a bronze medallion with a likeness of our namesake, HMS Vanguard (Lord
Nelson's flagship at The Battle of the Nile); a clock built circa 1816 in
Scotland, featuring a portrait of Nelson (who is also shown, accepting a
surrender, in a detail from a nineteenth-century engraving); and several views
of our recently completed campus, which is steeped in nautical imagery--from
our buildings named after Nelson's warships (Victory, Majestic, and Goliath are
three shown), to our artwork and ornamental compass rose.
<PAGE> 2
VANGUARD HAS ALWAYS STRIVED TO BE THE STANDARD-BEARER for mutual fund
disclosure, going well beyond the "letter of the law" in our shareholder
communications. During the past year, we raised the standard once again by
rewriting and reformatting our Fund prospectuses. They are designed to ensure
that prospective investors fully understand, before they make an investment,
each Fund's investment strategies, risks, and costs. In that spirit, we have
redesigned our Annual Reports to shareholders, which provide a comprehensive
discussion and analysis of the year's results in the context of each Fund's
investment objectives and policies. Since Vanguard has long been recognized for
the quality and content of these Fund Reports, our overriding objective was to
maintain the character of the previous Reports, while adding information to
assist shareholders in understanding the investment characteristics of their
Fund.
THE NEW FUND REPORTS INCLUDE A MESSAGE TO SHAREHOLDERS from Chairman John C.
Bogle and President John J. Brennan. This Message continues to provide a candid
assessment of the Fund's performance relative to an appropriate unmanaged
market benchmark and a peer group of mutual funds with similar investment
policies. It also reviews the principal factors contributing to--and detracting
from--the returns earned by the Fund. To help you evaluate your Fund's
current-year performance, the Message includes a discussion of the Fund's
long-term investment results, as well as a look ahead to the prospects for the
coming year. A recap of the financial markets, which had been included as part
of the Chairman's letter, now appears in The Markets In Perspective. This
overview covers the world's financial markets, putting the results of the
Fund's strategy in a global perspective.
THE PORTFOLIO PROFILE REPRESENTS AN ADDITION TO OUR FUND REPORTS. In this day
and age, many investors use detailed statistical information to evaluate their
mutual fund holdings, and our new Portfolio Profile furnishes shareholders with
comprehensive data on key characteristics--sector diversification, volatility,
top-ten holdings, among others--that ultimately define how a Fund is likely to
perform in various market environments. For this information to be used
effectively, we include a brief description of the profiled characteristics.
The Report From The Adviser (for our traditionally managed Funds) now covers
specific topics that we have defined as being the important ones for the
adviser to address--and we do our best to ensure that this Report is written in
the same simple and candid manner that characterizes all Vanguard
communications. Finally, each Adviser's Report will include an inset reminder
of the adviser's basic investment philosophy.
WE TRUST THAT THIS REDESIGNED FUND REPORT will continue to meet your need for a
fair, candid, and clear presentation of your Fund's investment results and a
thorough portfolio review. We welcome any comments that you might have at any
time regarding these Reports.
CONTENTS
A Message To
Our Shareholders
1
The Markets
In Perspective
4
Report From
The Adviser
6
Portfolio
Profile
8
Performance
Summary
10
Financial
Statements
11
Report Of
Independent
Accountants
17
Directors And
Officers
INSIDE BACK COVER
<PAGE> 3
[PHOTO]
JOHN C. BOGLE
[PHOTO]
JOHN J. BRENNAN
FELLOW SHAREHOLDER,
During a year when the stock market continued its rapid ascent,
Vanguard/PRIMECAP Fund provided a solid absolute return, ending its fiscal year
on December 31, 1996, with an +18.3% advance. On a relative basis, however, our
return failed to keep pace with those of our comparative benchmarks.
The following table compares the Fund's twelve-month total return (capital
change plus reinvested dividends) with that of the unmanaged Standard & Poor's
500 Composite Stock Price Index--dominated by large, blue chip stocks--and the
average growth mutual fund. Our Fund's return is based on an increase in net
asset value from $26.23 per share on December 31, 1995, to $30.08 per share on
December 31, 1996, with the latter figure adjusted for a dividend of $0.20 per
share paid from net investment income and distributions totaling $0.73 per
share paid from net realized capital gains.
<TABLE>
<CAPTION>
- -----------------------------------------
TOTAL RETURN
YEAR ENDED
DECEMBER 31, 1996
- -----------------------------------------
<S> <C>
Vanguard/PRIMECAP Fund +18.3%
- -----------------------------------------
Average Growth Fund +19.2%
- -----------------------------------------
S&P 500 Index +23.0%
- -----------------------------------------
</TABLE>
1996 PERFORMANCE OVERVIEW
In a nearly ideal environment of moderate economic growth, rising corporate
profits, and continued low inflation, the U.S. stock market flourished during
1996. Interest rates fluctuated substantially, rising early in the year along
with estimates of the economy's strength, then declining in the autumn as
estimates of economic growth abated--and with them, inflation anxieties.
However, interest rates closed the year with a sharp upward spike in December.
The yield on the benchmark 30-year U.S. Treasury bond finished the year at
6.6%--up about six-tenths of a percentage point from 6.0% at the end of
1995--driving the price of the long bond down by about -8%.
In contrast, the price trend for common stocks was virtually one-way: up.
The S&P 500 Index provided positive returns in all but two months (July and
December), as both growth stocks and value stocks turned in strong
performances. While returns on these two groups are quite similar over long
periods, they often diverge over shorter periods. In 1996, the S&P/BARRA Growth
Index earned a return of +24.0%, not far ahead of the S&P/BARRA Value Index,
which provided a return of +22.0%.
The performance of the market's sectors varied widely, however. By far,
our heaviest sector "bet" was in the market-leading technology sector, in which
we held an average weighting during 1996 nearly four times that of the S&P 500
Index (41% of Fund assets versus 11% of the Index). Yet being in the "right"
sector was no guarantor of success in 1996, because the lion's share of that
sector's +43% return came from only a handful of the biggest technology
companies. In fact, the three largest tech stocks (Intel, Microsoft, and IBM)
provided an astounding +94% average return versus a return of +5% for the
technology sector of the Russell 2000 Index of small-cap stocks.
This large-cap bias extended to many other market sectors, to the
detriment of most diversified growth funds, including ours. PRIMECAP's typical
holding has a market
1
<PAGE> 4
capitalization of about $5 billion versus a median market cap of about $25
billion for the S&P 500 Index.
Our performance was also hurt by our emphasis on the transportation sector,
in which we held about 15% of assets (versus 1.5% for the Index). After a
strong start during the first half of 1996, the sector faltered as airline
stocks stalled. On the positive side, our performance was buoyed by our lack of
representation in the market-lagging utilities sector and by our low relative
weighting--and fine stock selection--in the companies constituting the
consumer-cyclical sector.
Like most other equity mutual funds, PRIMECAP holds cash reserves to
provide liquidity; during 1996, our performance relative to the Index was
impeded by our 7% cash position. Clearly, even a modest cash reserve on the
sidelines of the stock market was a negative factor during a year when the
market staged a +23% advance.
As you know, we made a decision in 1996 to reopen PRIMECAP to new investors
as of October 31. We had closed the Fund in March 1995 after remarkable
technology-driven returns brought a torrent of cash into PRIMECAP. At the time,
we believed that some of these purchases came from investors seeking "hot"
performance over the short term. Our concern was that these short-term
"speculators" would threaten the interests of our long-term shareholders. Our
decision to reopen the Fund reflected our belief that the frenzy surrounding
the Fund had abated, that capital flows would be manageable, and that the
potential detriment to our shareholders had diminished. So far, our judgment
has been confirmed; since the Fund's reopening, cash flows have remained at
manageable levels.
LONG-TERM PERFORMANCE OVERVIEW
As shown in the table below, PRIMECAP continues to hold a long-term performance
advantage over the average growth fund. However, our Fund's return during the
past decade fell short of the S&P 500 Index, a very tough competitive standard.
For PRIMECAP shareholders, our annual performance margin has resulted in a
significant monetary advantage over the average growth mutual fund. A $10,000
investment in PRIMECAP a decade ago would have grown to $40,508 by the end of
1996; the same sum invested in the average growth fund would have grown to
$33,837. The difference of $6,671 is equal to fully two-thirds of the initial
investment.
<TABLE>
<CAPTION>
- ------------------------------------------------------
TOTAL RETURN
10 YEARS ENDED DECEMBER 31, 1996
--------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- ------------------------------------------------------
<S> <C> <C>
Vanguard/PRIMECAP Fund +15.0% $40,508
- ------------------------------------------------------
Average Growth Fund +13.0% $33,837
- ------------------------------------------------------
S&P 500 Index +15.3% $41,491
- ------------------------------------------------------
</TABLE>
That said, our performance during the past decade did not better that of
the S&P 500 Index. Exceeding the returns of this broad-based benchmark is our
goal, of course, but we should acknowledge that doing so is a tall order--not
just for PRIMECAP Fund, but for all mutual funds. The reason is that the Index
is a theoretical construct that bears none of the administrative, operating,
and investment management expenses that all mutual funds incur. Additionally,
the Index does not hold cash, a significant edge when stock prices are rising,
as they were for most of the past decade.
We should emphasize that future returns from the stock market may be lower
than those of the past decade, which by historical standards was an unusually
bountiful era for
2
<PAGE> 5
stocks. Indeed, with stock prices at high levels based on several valuation
measures, there is ample reason to expect returns to be lower in the coming
decade.
In addition to the risk that the stock market will someday take back some
of the gains it has provided during recent years, PRIMECAP carries the risk
that comes with investing a relatively high proportion of its assets in its ten
largest holdings. Our Fund's top-ten holdings make up about 36% of its total
assets; our position in the technology sector (43% of equities at the end of
1996) also reflects a substantial commitment. These concentrations will cause
the Fund's returns to diverge from those of the market and its peers; making
these divergences positive is what active portfolio management is all about.
IN SUMMARY
Most mutual fund investors understand that volatility risk is a measure of how
much an investment may fluctuate in value over a given period of time. But many
investors today have experienced only "upside volatility." The U.S. stock
market has been rising--with only a few, relatively brief setbacks--for nearly
15 years, essentially the entire lifespan of Vanguard/PRIMECAP Fund.
Against this backdrop, it seems appropriate to step back and assess the
outlook for the financial markets. While no one can accurately predict what
will happen over the next decade--or even the next year--it seems unlikely that
stocks will enjoy a repeat of the exceptional returns of this remarkable era.
Indeed, there are sure to be some rough seas ahead. Nonetheless, we believe
that investors who maintain a balanced portfolio of stock funds, bond funds,
and money market funds will withstand the volatility of the financial markets
and be rewarded. "Stay the course" has proved wise counsel in the past, and we
see no reason why it should not continue to be in the future.
/s/ JOHN C BOGLE /s/ JOHN J. BRENNAN
Chairman of the Board President
January 13, 1997
3
<PAGE> 6
THE MARKETS IN PERSPECTIVE: YEAR ENDED DECEMBER 31, 1996
[PHOTO]
U.S. EQUITY MARKETS
The stock market in 1996 could not match its astonishing 37.6% return of the
previous year--but it made a good run, with the Standard & Poor's 500 Composite
Stock Price Index up by 23.0%. When the two years are considered cumulatively,
the S&P 500 Index has risen 69.2%. Not surprisingly, many of the factors that
drove the market higher in 1995 were still at work: Once again, steady economic
growth, low inflation, and solid earnings growth were powerful motivators.
The market's gains, however, were far from evenly distributed. Investors
strongly favored larger companies, such as those that dominate the S&P 500
Index. In fact, even within the Index, it was the largest companies that
prevailed: The 50 biggest (which account for roughly half the Index's market
value) gained 26.7% in 1996, compared with an increase of 23.0% for the entire
Index. Looking at the S&P 500 Index's performance by sector, technology stocks
were strongest, closing the year with a 42.5% gain. Financial stocks were a
close second, gaining 35.5%. Utilities, plagued early in the year by higher
interest rates and a rapidly changing competitive landscape, eked out a meager
1.8% return, the lowest within the Index.
With the largest companies performing so well, most smaller issues could
not keep pace. This was evidenced in the considerable difference between the
23.0% return of the S&P 500 Index and the 16.5% return of the Russell 2000
Index of small stocks. Even for the smaller companies, there was a significant
range of performance among sectors. Energy stocks led the Russell 2000 Index
with a 62.0% gain for the year. Here, rising prices, limited exposure to the
cyclical refining business, and a reduced number of competitors created a
favorable environment for the stocks. At the other end of the spectrum were
health-care stocks, which showed a loss of -3.3%.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED DECEMBER 31, 1996
-------------------------------
1 YEAR 3 YEARS 5 YEARS
- -------------------------------------------------------------------
<S> <C> <C> <C>
Equity
S&P 500 Index 23.0% 19.7% 15.2%
Russell 2000 Index 16.5 13.7 15.6
MSCI-EAFE Index 6.4 8.6 8.5
- -------------------------------------------------------------------
Fixed-Income
Lehman Aggregate Bond Index 3.6% 6.0% 7.0%
Lehman 10-Year Municipal
Bond Index 4.5 5.3 7.5
Salomon 90-Day U.S. Treasury Bills 5.3 5.1 4.4
- -------------------------------------------------------------------
Other
Consumer Price Index 3.3% 2.8% 2.8%
- -------------------------------------------------------------------
</TABLE>
U.S. FIXED-INCOME MARKETS
At year-end, the yield on the 30-year U.S. Treasury bond was 6.64%, noticeably
higher than its 5.95% level on December 31, 1995. The change in rates during
1996 reflects increased concern about the prospects for rising inflation, due
to indications of greater than expected strength in the economy.
When the year began, the general expectation was that modest economic
growth and benign inflation would continue, giving the Federal Reserve no
reason to boost inter-
4
<PAGE> 7
est rates. That complacency was shattered by an exceptionally strong February
jobs report, the first of what turned out to be a succession of signs that in
fact the economy was growing at a much faster--and potentially
inflation-inducing--pace. The bond market reacted swiftly to meet the perceived
risk: The 30-year Treasury bond's yield jumped from just below 6.0% at the end
of 1995 to 6.7% in late March. The next several months saw a consistent pattern
in which bond yields rose on the Friday of the jobs-report release only to fall
back by the middle of the month. Hindsight shows that most of the worry was
wasted: Inflation, as measured by the Consumer Price Index, remained near an
annualized rate of 3.3%. But increasing signs of growth in late November and
December reignited inflation concerns and caused bonds to finish the year on a
sour note.
Despite the numerous setbacks suffered by the bond market in 1996, indexes
were able to finish the year with positive total returns. Although the specter
of the Federal Reserve Board loomed large during the year, in fact the Board
acted only once, lowering the federal funds rate by a total of 0.25% in
January.
Corporate bonds, mortgage-backed issues, and municipals were three
relatively bright spots in 1996. The strength in earnings that benefited stock
prices extended to the corporate bond sector as well. These bonds, especially
those of lower credit quality, performed well relative to Treasuries, supported
by general confidence in companies' ability to meet payments. The
stable-to-rising interest-rate environment throughout most of the year
benefited another large segment of the bond market--mortgage-backed
securities--as the threat of refinancings receded. Finally, municipal bonds
outpaced their U.S. Treasury counterparts. The sector was shielded to a certain
extent from the inflation wars of the Treasury market, as demand outstripped
supply for much of the year.
INTERNATIONAL EQUITY MARKETS
Investors who assess international markets by the often-cited EAFE
benchmark--the Morgan Stanley Capital International-Europe, Australasia, Far
East Index, with its 1996 return of 6.4%--could have overlooked a striking
regional disparity between the Euro-pean and Pacific markets. Europe's markets
gained 21.4% during the year, while their Pacific counterparts posted a decline
of -8.2%. Clearly, the outlook and environments that characterized the
European and Far East markets were quite different.
The poor returns in the Pacific region largely reflected ongoing concern
about the health of the Japanese economy. Growth in Japan has remained modest
at best for several years despite government efforts to stimulate the economy
through public works programs and tax incentives. In Europe, the picture was
dramatically different, with the region benefiting from a variety of factors.
Among the most important were (1) ongoing efforts to lower government deficits
consistent with the Maastricht Treaty guidelines, (2) improving economic
growth, and (3) a greater commitment by corporate executives to increasing
"shareholder value."
5
<PAGE> 8
REPORT FROM THE ADVISER
[PHOTO]
During 1996, Vanguard/PRIMECAP Fund's total return of 18.3% lagged
the 23.0% recorded by the unmanaged Standard & Poor's 500 Composite Stock Price
Index and the 19.2% achieved by the average growth mutual fund.
It was an especially rewarding year for those who held primarily
large-capitalization blue chips: The Dow Jones Industrial Average returned
nearly 29%. In the broader market, performance was similarly concentrated in
the stocks of companies that are either household names or widely regarded as
dominant in their industries. These were safe stocks that could dependably meet
earnings estimates. For advisers like PRIMECAP Management--who tend to stray
from the beaten path looking for opportunities in less-recognized stocks, or at
least those that have a blemish or two and are less loved by Wall Street--it
was a challenging year. For details about the Fund's performance, please refer
to the Message To Shareholders, which begins on page 1.
The Fund maintained its substantial commitment to technology stocks during
1996, with approximately 40% of the portfolio deployed in the sector. This
proved to be a good allocation, as technology was the best-performing sector in
the market. However, the sector's gains were substantially concentrated among a
handful of the largest-capitalization stocks--Intel, Microsoft, Cisco, and IBM.
Concluding that these companies enjoyed sustainable competitive advantage and
pricing power and would meet earnings expectations, investors enthusiastically
bid them up an average of 88% in 1996. Considering that these four stocks have
an aggregate market capitalization exceeding $300 billion, their performance
dramatically and disproportionately influenced the technology sector's return
of 43%. By contrast, the average science and technology mutual fund provided a
return of 19%.
The Fund's exposure to the "big four" technology stocks was in Intel, our
largest holding. Its 130% gain contributed meaningfully to our results.
However, we are unlikely to focus our attention on companies that are
universally regarded as dominant or safe. We often find that these stocks in
fact harbor the greatest risk simply because the perception of risk is so low.
We are more attracted to companies whose current stories are not crystal-clear,
but whose potential is. We like companies whose current earnings may be
unpredictable, even disappointing, but whose future earnings power may be
great. We search for companies not necessarily characterized as dominant, but
which often are industry leaders with differentiated products that afford them
some degree of pricing power.
The Fund's technology holdings include many names fitting these criteria.
Ericsson and Motorola are undisputed leaders in wireless communications
equipment. Hewlett-Packard is the premier provider of printers and open-system
computers. Electronic Arts is the leading independent developer of
entertainment software. AMP is the largest connector company in the world.
Evans & Sutherland supplies more visual systems for pilot-training simulators
than any other company in the world. LSI Logic is the largest domestic supplier
of
INVESTMENT PHILOSOPHY
The Fund reflects a belief that superior long-term investment
results can be achieved by selecting stocks with prices lower
than the "fundamental value" of the underlying companies,
based on the investment adviser's assessment of such factors
as their industry positions, growth potential, and expected
profitability.
6
<PAGE> 9
custom logic solutions to manufacturers of electronic products. Adobe Systems
develops software that is the de facto standard among professionals developing
graphically rich content in print or electronic media. Octel is the leading
vendor of voice-mail and messaging systems. Texas Instruments enjoys clear
global leadership in digital signal processors and is the largest domestic
manufacturer of DRAM chips. Tandem Computers and Stratus Computer are the
leading manufacturers of fault-tolerant computers.
Many of these stocks performed well in 1996. Several, however, performed
poorly. The companies experienced earnings shortfalls, and the stocks were
punished. The market was unforgiving when companies missed earnings targets.
Our perspective is different from that of the market. We have tremendous
patience for stocks with uncertain or even turbulent short-term prospects when
the long-term outlook justifies the wait. We like our technology selections. As
we have attempted to convey, our selections are market leaders in exciting
businesses. In time, we expect the market to award them higher valuations.
The performance of our transportation stocks (9.9% return for the year)
was disappointing. In the first half of the year, these stocks gained 16%.
Fundamentals, particularly among the airlines, looked promising. At many of the
major carriers, traffic, load factors, and yields were increasing concurrent
with flat-to-declining capacity and aggressive efforts to contain costs. Many
airlines were reporting record earnings and cash flow. However, a confluence of
events in the third quarter caused airline stocks to decline. Of greatest
impact was the TWA Flight 800 tragedy. The suspicion of terrorist involvement
and the industry's potential vulnerability to such activities alarmed
investors. Second, the reinstatement of the excise tax on airline tickets
caused analysts to lower earnings estimates. Finally, oil prices rose
significantly. All of these issues are serious. However, our view of the
industry dynamics is unchanged. The reinstatement of the excise tax is a
one-time event. The price of oil is a cost of doing business, like the price of
steel for automakers; raw-material prices will always fluctuate. Repercussions
from the TWA tragedy will wane with time, a process that has already begun.
Fundamentally, we perceive our airline holdings as exceptionally attractive.
Traffic is growing, and capacity is tight. Load factors and yields continue to
improve. Earnings and cash flow are at record levels and increasing. Barriers
to entry are emerging, and consumers are distinguishing between high-quality
carriers and no-frills operators. Finally, the valuations are compelling.
We look forward with confidence. Our portfolio contains many companies
with leadership positions in vibrant markets. Many are not household names.
Others are not considered safe because they have recently experienced an
earnings shortfall. For these reasons they suffered in 1996. However, as they
begin realizing their exciting potential, we expect market perception and
valuation to follow accordingly.
Howard B. Schow, Portfolio Manager
Theo A. Kolokotrones, Portfolio Manager
Joel P. Fried, Assistant Portfolio Manager
PRIMECAP Management Company
January 10, 1997
7
<PAGE> 10
PORTFOLIO PROFILE: PRIMECAP FUND
DECEMBER 31, 1996
This Profile provides a snapshot of the Fund's characteristics, compared where
appropriate to an unmanaged index. Key elements of this Profile are defined on
page 9.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
- -----------------------------------------
PRIMECAP S&P 500
- -----------------------------------------
<S> <C> <C>
Number of Stocks 98 500
Median Market Cap $5.4B $24.5B
Price/Earnings Ratio 21.2x 19.6x
Price/Book Ratio 2.9x 3.4x
Yield 0.5% 2.0%
Return on Equity 14.4% 19.6%
Earnings Growth Rate 22.0% 13.5%
Foreign Holdings 8.4% 3.7%
Turnover Rate 10% --
Expense Ratio 0.59% --
Cash Reserves 6.7% --
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- -----------------------------------------
PRIMECAP S&P 500
- -----------------------------------------
<S> <C> <C>
R-Squared 0.66 1.00
Beta 1.02 1.00
</TABLE>
INVESTMENT FOCUS
- -----------------------------------------
[FIGURE]
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- --------------------------------------------
<S> <C>
Intel Corp. 6.0%
Federal Express Corp. 4.4
Texas Instruments, Inc. 4.4
AMR Corp. 3.9
Guidant Corp. 3.5
Delta Air Lines, Inc. 3.4
L.M. Ericsson Telephone Co. 3.4
Motorola, Inc. 2.5
American International Group, Inc. 2.4
Tandem Computers, Inc. 2.3
- --------------------------------------------
Top Ten 36.2%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCK)
- -----------------------------------------------------------------------------------------------------
DECEMBER 31, 1995 DECEMBER 31, 1996
-------------------------------------------
PRIMECAP PRIMECAP S&P 500
-------------------------------------------
<S> <C> <C> <C>
Basic Materials . . . . . . . . . . . 4.2% 4.1% 6.2%
Capital Goods & Construction . . . . . 3.9 4.6 8.4
Consumer Cyclical . . . . . . . . . . 6.1 7.3 12.1
Consumer Staples . . . . . . . . . . . 0.0 2.7 12.4
Energy . . . . . . . . . . . . . . . . 0.5 0.6 9.7
Financial . . . . . . . . . . . . . . 11.3 9.9 15.0
Health Care . . . . . . . . . . . . . 12.8 11.4 10.4
Technology . . . . . . . . . . . . . . 39.7 43.3 12.1
Transport & Services . . . . . . . . . 16.3 15.1 1.5
Utilities . . . . . . . . . . . . . . 0.0 0.0 9.9
Miscellaneous . . . . . . . . . . . . 5.2 1.0 2.3
- -----------------------------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 11
[PHOTO]
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the fluctuations in the overall market (or appropriate market
index). The market, or index, has a beta of 1.00, so a portfolio with a beta of
1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
EARNINGS GROWTH RATE. The annual average rate of growth in earnings over the
past five years for the stocks now in a portfolio. Expense Ratio. The
percentage of a portfolio's average net assets used to pay its annual
administrative and advisory expenses. These expenses directly reduce returns to
investors. The average expense ratio of a stock mutual fund was 1.34% in 1995.
FOREIGN HOLDINGS. The percentage of a portfolio's investments represented by
stocks or American Depository Receipts (ADRs) of companies based outside the
United States.
INVESTMENT FOCUS. This grid indicates the focus of a portfolio in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. The midpoint of market capitalization (market price x shares
outstanding) of the stocks in a portfolio. Half the stocks in the portfolio
have higher market capitalizations and half lower.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
holds, the more diversified it is and the more likely to perform in line with
the overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a portfolio, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a portfolio, the weighted average P/E of the
stocks it holds. P/E is an indicator of market expectations about corporate
prospects; the higher the P/E, the greater the expectations for a company's
future growth.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a portfolio, the weighted average return
on equity for the companies represented in the portfolio.
R-SQUARED. A measure of how much of a portfolio's past returns can be explained
by the returns from the overall market (or its benchmark index). If a
portfolio's total return were precisely synchronized with the overall market's
return, its R-squared would be 1.00. If a portfolio's returns bore no
relationship to the market's returns, its R-squared would be 0.
SECTOR DIVERSIFICATION. The percentage of a portfolio's common stocks invested
in each of the major industry classifications that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of a portfolio's total net assets in its
ten largest investments (the average for stock mutual funds is about 25%). As
this percentage rises, a portfolio's returns are likely to be more volatile,
since its return is more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the past year.
Portfolios with high turnover rates incur higher transaction costs and are more
likely to realize and distribute capital gains (which are taxable to
investors). The average turnover rate for stock mutual funds is about 80%.
YIELD. A snapshot of a portfolio's income from interest and dividends. The
yield, expressed as a percentage of the portfolio's net asset value, is based
on income earned over the past 30 days and is annualized, or projected forward
for the coming year.
9
<PAGE> 12
PERFORMANCE SUMMARY: PRIMECAP FUND
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Fund. Note, too, that
both share price and return can fluctuate widely so that an investment in the
Fund could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: 11/1/84-12/31/96
- ------------------------------------------
PRIMECAP FUND S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ------------------------------------------
<S> <C> <C> <C> <C>
1984 4.9% 0.0% 4.9% 0.6%
1985 35.6 0.2 35.8 31.8
1986 21.8 1.7 23.5 18.7
1987 -3.2 0.9 -2.3 5.3
1988 13.7 1.0 14.7 16.6
1989 20.2 1.4 21.6 31.7
1990 -3.8 1.0 -2.8 -3.1
1991 31.8% 1.3% 33.1% 30.5%
1992 8.2 0.8 9.0 7.6
1993 17.6 0.4 18.0 10.1
1994 10.7 0.7 11.4 1.3
1995 34.4 1.1 35.5 37.6
1996 17.5 0.8 18.3 23.0
</TABLE>
See Financial Highlights table on page 15 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: 12/31/86-12/31/96
- ------------------------------------------
Cumulative Performance 10 yr Graph - Portfolio/ Benchmark - Vanguard/PRIMECAP
Fund Vanguard/PRIMECAP Fund Lipper Growth Standard & Poor's 500 Index
<S> <C> <C> <C> <C>
1986 12 10000 10000 10000
1987 03 12086 12020 12136
1987 06 12387 12233 12745
1987 09 12777 12942 13587
1987 12 9771 10115 10526
1988 03 11009 10864 11126
1988 06 11650 11467 11867
1988 09 11243 11376 11907
1988 12 11203 11527 12275
1989 03 11900 12336 13145
1989 06 12616 13296 14305
1989 09 13769 14668 15837
1989 12 13624 14460 16164
1990 03 13733 14127 15678
1990 06 14785 15118 16664
1990 09 11597 12711 14374
1990 12 13244 13667 15662
1991 03 16313 16047 17937
1991 06 15815 15883 17896
1991 09 16412 17124 18853
1991 12 17633 18600 20434
1992 03 17484 18361 19918
1992 06 16979 17792 20296
1992 09 17153 18399 20936
1992 12 19219 20049 21991
1993 03 20206 20540 22951
1993 06 20730 20651 23063
1993 09 21827 21704 23659
1993 12 22683 22172 24207
1994 03 22605 21318 23289
1994 06 22790 20851 23387
1994 09 24731 22012 24530
1994 12 25272 21695 24527
1995 03 27791 23197 26915
1995 06 31662 25491 29484
1995 09 34365 27707 31827
1995 12 34239 28377 33743
1996 03 35402 29764 35554
1996 06 37186 31150 37150
1996 09 37803 32109 38298
1996 12 40508 33837 41491
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1996
------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- ----------------------------------------------------------------------
<S> <C> <C> <C> <C>
PRIMECAP FUND 18.31% 18.10% 15.02% $40,508
AVERAGE GROWTH FUND 19.24 12.71 12.96 33,837
S&P 500 INDEX 22.96 15.22 15.29 41,491
- ----------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED 12/31/96
- --------------------------------------------------------------------------------------
10 YEARS
INCEPTION -----------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
PRIMECAP Fund 11/1/84 18.31% 18.10% 14.07% 0.95% 15.02%
- --------------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
FINANCIAL STATEMENTS
DECEMBER 31, 1996
[PHOTO]
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, preferred stocks, bonds,
etc.) and by industry sector. Other assets are added to, and liabilities are
subtracted from, the value of Total Investments to calculate the Fund's Net
Assets. Finally, Net Assets are divided by the outstanding shares of the Fund
to arrive at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying
the composition of the Fund's net assets on both a dollar and per-share basis.
Because all income and any realized gains must be distributed to shareholders
each year, the bulk of net assets consists of Paid in Capital(money invested by
shareholders). The amounts shown for Undistributed Net Investment Income and
Accumulated Net Realized Gains usually approximate the sums the Fund had
available to distribute to shareholders as income dividends or capital gains as
of the statement date. Any Accumulated Net Realized Losses, and any cumulative
excess of distributions over net income or net realized gains, will appear as
negative balances. Unrealized Appreciation (Depreciation) is the difference
between the market value of the Fund's investments and their cost, and reflects
the gains (losses) that would be realized if the Fund were to sell all of its
investments at their statement-date values.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------
MARKET
VALUE*
PRIMECAP FUND SHARES (000)
- ---------------------------------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (93.3%)
- ---------------------------------------------------------------------------------
BASIC MATERIALS (3.7%)
Engelhard Corp. $ 2,040,000 $ 39,015
(1) MacDermid, Inc. 567,000 15,592
Monsanto Co. 550,000 21,381
Quaker Chemical Corp. 140,000 2,292
Stepan Co. 300,000 6,112
Temple-Inland Inc. 1,300,000 70,362
------------
154,754
------------
CAPITAL GOODS & CONSTRUCTION (3.8%)
BW/IP, Inc. 200,000 3,300
Belden Inc. 349,000 12,913
Caterpillar, Inc. 755,000 56,814
Donaldson Co., Inc. 540,000 18,090
(1) Granite Construction Co. 1,400,000 26,600
Kennametal, Inc. 1,140,000 44,318
------------
162,035
------------
CONSUMER CYCLICAL (5.7%)
Arvin Industries, Inc. 675,000 16,706
- BET Holdings Inc. Class A 380,000 10,925
- Coherent, Inc. 500,000 21,250
- Electronic Arts Inc. 900,000 26,888
- Filene's Basement Corp. 995,000 4,042
Fleetwood Enterprises, Inc. 425,000 11,688
- GC Cos. 200,000 6,925
Harcourt General, Inc. 590,000 27,214
Knight-Ridder, Inc. 162,400 6,212
McClatchy Newspapers, Inc. 390,000 13,650
Polaroid Corp. 200,000 8,700
- Price/Costco Inc. 3,500,000 87,938
------------
242,138
------------
CONSUMER STAPLES (2.3%)
Pioneer Hi Bred International 600,000 42,000
The Seagram Co. Ltd. 1,475,000 57,156
------------
99,156
------------
ENERGY (0.2%)
Schlumberger Ltd. 75,000 7,491
------------
FINANCIAL (8.9%)
American International
Group, Inc. 944,616 102,255
(1) Avemco Corp. 650,000 10,156
City National Corp. 621,485 13,440
General Re Corp. 570,000 89,918
Marsh & McLennan Cos., Inc. 120,000 12,480
NationsBank Corp. 100,000 9,775
State Street Boston Corp. 720,000 46,440
Torchmark Corp. 485,000 24,493
Transatlantic Holdings 375,000 30,188
Zurich Reinsurance Centre
Holdings, Inc. 1,089,000 34,031
------------
373,176
------------
HEALTH CARE (10.5%)
American Home Products Corp. 180,000 10,553
Block Drug Co. Class A 164,800 7,581
- Boston Scientific Corp. 205,000 12,300
Guidant Corp. 2,605,316 148,503
Johnson & Johnson 1,100,000 54,725
Eli Lilly & Co. 980,000 71,540
- Lynx Therapeutics, Inc. 72,900 292
Medtronic, Inc. 988,444 67,214
- Mycogen Corp. 800,000 16,800
</TABLE>
11
<PAGE> 14
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------
MARKET
VALUE*
PRIMECAP FUND SHARES (000)
- ---------------------------------------------------------------------------------
<S> <C> <C>
Pharmacia & Upjohn, Inc. $ 1,260,000 $ 49,928
-(1) Tripos Inc. 155,000 1,821
------------
441,257
------------
TECHNOLOGY (38.3%)
COMPUTER & COMPUTER RELATED (10.0%)
Adobe Systems, Inc. 2,200,000 82,225
- Bay Networks, Inc. 3,270,000 68,261
- Digital Equipment Corp. 1,148,000 41,758
Hewlett-Packard Co. 1,320,000 66,330
Reuters Holdings PLC ADR 740,000 56,610
- Stratus Computer, Inc. 377,000 10,273
-(1) Tandem Computers, Inc. 6,991,000 96,126
ELECTRONIC COMPONENTS & INSTRUMENTS (22.6%)
AMP, Inc. 832,500 31,947
- Dionex Corp. 510,000 17,850
-(1) Evans & Sutherland
Computer Corp. 840,000 20,370
Intel Corp. 1,914,000 250,495
- LSI Logic Corp. 1,188,700 31,798
Measurex Corp. 540,000 12,960
Molex, Inc. 125,000 4,875
Molex, Inc. Class A 125,000 4,437
Motorola, Inc. 1,700,000 104,337
-(1) Octel Communications Corp. 2,650,000 45,712
Perkin-Elmer Corp. 940,000 55,342
Sony Corp. ADR 965,000 63,328
- Symbol Technologies, Inc. 1,111,000 49,162
Tektronix, Inc. 1,400,000 71,750
Texas Instruments, Inc. 2,910,000 185,513
TELECOMMUNICATIONS (5.7%)
L.M. Ericsson Telephone Co.
ADR Class B 4,600,000 138,575
L.M. Ericsson Telephone Co.
Cvt. Pfd. 4.25% 620,000 2,577
-(1) Plantronics, Inc. 804,000 36,180
- Tellabs, Inc. 1,600,000 60,200
------------
1,608,991
------------
TRANSPORT & SERVICES (14.1%)
- AMR Corp. 1,855,000 163,472
APL Ltd. 726,350 17,160
(1) Airborne Freight Corp. 1,580,000 36,933
- Alaska Air Group, Inc. 700,000 14,700
Delta Air Lines, Inc. 2,005,000 142,104
- Federal Express Corp. 4,200,000 186,900
Southwest Airlines Co. 1,350,000 29,869
------------
591,138
------------
MISCELLANEOUS (5.8%)
Manpower Inc. 1,170,000 38,025
Other (4.9%) 206,344
------------
244,369
------------
- ---------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $2,475,835) 3,924,505
- ---------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (6.0%)
- ---------------------------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
6.39%, 1/2/97
(COST $250,400) $250,400 $ 250,400
- ---------------------------------------------------------------------------------
TOTAL INVESTMENTS (99.3%)
(COST $2,726,235) 4,174,905
- ---------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (0.7%)
- ---------------------------------------------------------------------------------
Other Assets--Notes C and F 80,100
Liabilities--Note F (51,019)
------------
29,081
- ---------------------------------------------------------------------------------
NET ASSETS (100%)
- ---------------------------------------------------------------------------------
Applicable to 139,780,777 outstanding
$.001 par value shares
(authorized 400,000,000 shares) $4,203,986
=================================================================================
NET ASSET VALUE PER SHARE $30.08
=================================================================================
</TABLE>
* See Note A in Notes to Financial Statements.
- - Non-Income Producing Security.
ADR--American Depository Receipt.
(1)Considered an affiliated company as the Fund owns more than 5% of the
outstanding voting securities of such company.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------
AT DECEMBER 31, 1996, NET ASSETS CONSISTED OF:
- ---------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ---------------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $2,733,802 $19.56
Overdistributed Net
Investment Income (2,032) (.01)
Accumulated Net
Realized Gains 23,546 .17
Unrealized Appreciation--
Note E 1,448,670 10.36
- ---------------------------------------------------------------------------------
NET ASSETS $4,203,986 $30.08
=================================================================================
</TABLE>
12
<PAGE> 15
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the Fund during the
reporting period, and details the operating expenses charged to the Fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
PRIMECAP FUND
YEAR ENDED DECEMBER 31, 1996
(000)
- --------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 29,802
Interest 17,958
--------------
Total Income 47,760
--------------
EXPENSES
Investment Advisory Fees--Note B 10,439
The Vanguard Group--Note C
Management and Administrative 10,384
Marketing and Distribution 829
Taxes (other than income taxes) 273
Custodian Fees 16
Auditing Fees 12
Shareholders' Reports 145
Annual Meeting and Proxy Costs 56
Directors' Fees and Expenses 12
--------------
Total Expenses 22,166
- --------------------------------------------------------------------------------------
NET INVESTMENT INCOME 25,594
- --------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 106,160
- --------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 505,864
- --------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 637,618
======================================================================================
</TABLE>
13
<PAGE> 16
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the Fund's total net assets changed during the two
most recent reporting periods. The Operations section summarizes information
that is detailed in the Statement of Operations. The amounts shown as
Distributions to shareholders from the Fund's net income and capital gains may
not match the amounts shown in the Operations section, because distributions
are determined on a tax basis and may be made in a period different from the
one in which the income was earned or the gains were realized on the financial
statements. The Capital Share Transactions section shows the amount
shareholders invested in the Fund, either by purchasing shares or by
reinvesting distributions, as well as the amounts redeemed. The corresponding
numbers of Shares Issued and Redeemed are shown at the end of the Statement.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
PRIMECAP FUND
YEAR ENDED DECEMBER 31,
-----------------------------------
1996 1995
(000) (000)
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 25,594 $ 25,713
Realized Net Gain 106,160 78,807
Change in Unrealized Appreciation (Depreciation) 505,864 625,885
-----------------------------------
Net Increase in Net Assets Resulting from Operations 637,618 730,405
-----------------------------------
DISTRIBUTIONS
Net Investment Income (27,258) (26,218)
Realized Capital Gain (98,658) (68,839)
-----------------------------------
Total Distributions (125,916) (95,057)
-----------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 994,160 1,373,945
Issued in Lieu of Cash Distributions 124,436 93,789
Redeemed (663,154) (419,953)
-----------------------------------
Net Increase from Capital Share Transactions 455,442 1,047,781
- -----------------------------------------------------------------------------------------------------
Total Increase 967,144 1,683,129
- -----------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 3,236,842 1,553,713
-----------------------------------
End of Year $4,203,986 $3,236,842
=====================================================================================================
(1) Shares Issued (Redeemed)
Issued 35,931 58,906
Issued in Lieu of Cash Distributions 4,217 3,685
Redeemed (23,764) (16,973)
Net Increase in Shares Outstanding 16,384 45,618
=====================================================================================================
</TABLE>
14
<PAGE> 17
FINANCIAL HIGHLIGHTS
This table summarizes the Fund's investment results and distributions to
shareholders on a per-share basis. It also presents the Fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the Fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the Fund's total return; how much it costs to operate the
Fund; and the extent to which the Fund tends to distribute capital gains.
The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in
the Fund for one year. Finally, the table lists the Fund's Average Commission
Rate Paid, a disclosure required by the SEC beginning in 1996. This rate is
calculated by dividing total commissions paid on portfolio securities by the
total number of shares purchased and sold on which commissions were charged.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
PRIMECAP FUND
YEAR ENDED DECEMBER 31,
---------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1996 1995 1994 1993 1992
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $26.23 $19.98 $18.42 $16.19 $15.36
- -------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .19 .22 .12 .07 .12
Net Realized and Unrealized Gain (Loss) on Investments 4.59 6.84 1.97 2.82 1.24
---------------------------------------------------
Total from Investment Operations 4.78 7.06 2.09 2.89 1.36
---------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.20) (.22) (.12) (.07) (.12)
Distributions from Realized Capital Gains (.73) (.59) (.41) (.59) (.41)
---------------------------------------------------
Total Distributions (.93) (.81) (.53) (.66) (.53)
- -------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $30.08 $26.23 $19.98 $18.42 $16.19
=============================================================================================================
TOTAL RETURN 18.31% 35.48% 11.41% 18.03% 8.99%
=============================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $4,204 $3,237 $1,554 $791 $646
Ratio of Total Expenses to Average Net Assets 0.59% 0.58% 0.64% 0.67% 0.68%
Ratio of Net Investment Income to Average Net Assets 0.69% 0.99% 0.79% 0.44% 0.84%
Portfolio Turnover Rate 10% 7% 8% 16% 7%
Average Commission Rate Paid $.0637 N/A N/A N/A N/A
=============================================================================================================
</TABLE>
15
<PAGE> 18
NOTES TO FINANCIAL STATEMENTS
Vanguard/PRIMECAP Fund is registered under the Investment Company Act of 1940
as a diversified open-end investment company, or mutual fund.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The Fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Securities listed on an exchange are valued at the
latest quoted sales prices as of the close of trading on the New York Stock
Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such
securities not traded on the valuation date are valued at the mean of the
latest quoted bid and asked prices. Securities not listed on an exchange 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, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other
party to the agreement, retention of the collateral may be subject to legal
proceedings.
4. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
5. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. Under a contract that expires April 30, 1997, the Fund pays PRIMECAP
Management Company an investment advisory fee calculated at an annual
percentage rate of average net assets. For the year ended December 31, 1996,
the advisory fee represented an effective annual rate of 0.28% of the Fund's
average net assets.
C. The Vanguard Group 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 December 31,
1996, the Fund had contributed capital of $376,000 to Vanguard (included in
Other Assets), representing 1.9% of Vanguard's capitalization. The Fund's
directors and officers are also directors and officers of Vanguard.
D. During the year ended December 31, 1996, the Fund purchased $740,811,000 of
investment securities and sold $331,461,000 of investment securities, not
counting U.S. government securities and temporary cash investments.
E. At December 31, 1996, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $1,448,670,000,
consisting of unrealized gains of $1,488,697,000 on securities that had
risen in value since their purchase and $40,027,000 in unrealized losses on
securities that had fallen in value since their purchase.
F. The market value of securities on loan to broker/dealers at December 31,
1996, was $18,828,000, for which the Fund held cash collateral of $19,528,000.
16
<PAGE> 19
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Directors of
Vanguard/PRIMECAP 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/PRIMECAP Fund (the "Fund") at December 31, 1996, and the results of
its operations, the changes in its net assets and the financial highlights for
each of the periods indicated, 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 at December 31, 1996 by correspondence with the
custodian and, with respect to unsettled securities transactions, the
application of alternative auditing procedures, provide a reasonable basis for
the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
January 31, 1997
17
<PAGE> 20
SPECIAL 1996 TAX INFORMATION (UNAUDITED)
VANGUARD/PRIMECAP FUND
This information for the fiscal year ended December 31, 1996, is included
pursuant to provisions of the Internal Revenue Code.
The Fund designates $95,316,000 as capital gain dividends (from net
long-term capital gains), of which $75,729,000 was distributed to
shareholders in December 1996 and $19,587,000 will be distributed in March
1997.
For corporate shareholders, 71.5% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received
deduction.
All comparative mutual fund data are from Lipper Analytical Services, Inc. or
Morningstar unless otherwise noted.
18
<PAGE> 21
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman of the Board and Director of The Vanguard Group, Inc.
and of each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN, President, Chief Executive Officer, and Director of The
Vanguard Group, Inc. and of each of the investment companies in The
Vanguard Group.
ROBERT E. CAWTHORN, Chairman Emeritus and Director of Rhone-Poulenc Rorer Inc.;
Director of Sun Company, Inc. and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea Co.,
Alco Standard Corp., Raytheon Co., Knight-Ridder, Inc., and
Massa-chusetts Mutual Life Insurance Co.
BRUCE K. MACLAURY, President Emeritus of The Brookings Institution; Director of
American Express Bank Ltd., The St. Paul Companies, Inc., and National
Steel Corp.
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., Procter & Gamble 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; Principal of The Vanguard Group, Inc.; Treasurer
of each of the investment companies in The Vanguard Group.
KAREN E. WEST, Controller; Principal of The Vanguard Group, Inc.; Controller of
each of the investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
ROBERT A. DISTEFANO, Senior Vice President, Information Technology.
JAMES H. GATELY, Senior Vice President,
Individual Investor Group.
IAN A. MACKINNON, Senior Vice President,
Fixed Income Group.
F. WILLIAM MCNABB III, Senior Vice President, Institutional.
RALPH K. PACKARD, Senior Vice President and
Chief Financial Officer.
[THE VANGUARD LOGO]
Please send your comments to us at:
Post Office Box 2600, Valley Forge, Pennsylvania 19482
Fund Information: 1-800-662-7447
Individual Account Services: 1-800-662-2739
Institutional Investor Services: 1-800-523-1036
[email protected] http://www.vanguard.com
All Vanguard Funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before investing or sending money. Prospectuses
may be obtained directly from The Vanguard Group.
(C) 1996 Vanguard Marketing Corporation, Distributor
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[PHOTO]
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 Selected Value Portfolio
Vanguard/Trustees' Equity-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 Portfolios
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
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity-International
Portfolio
INDEX FUNDS
Vanguard Indes Trust
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Vanguard International Equity Index Fund
Vanguard Total International Portfolio
FIXED-INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Money Market Reserves
Vanguard Treasury Money Market Portfolio
Vanguard Admiral Funds
INCOME FUNDS
Vanguard Fixed Income Securities Fund
Vanguard Admiral Funds
Vanguard Preferred Stock Fund
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
Q590-12/96
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