<PAGE> 1
VANGUARD/
PRIMECAP FUND
Annual Report - December 31, 1997
[PHOTO]
[THE VANGUARD GROUP LOGO]
<PAGE> 2
OUR CREW MAKES THE DIFFERENCE
Throughout our history, The Vanguard Group has received considerable attention
as the low-cost provider of mutual funds. While such accolades are gratifying,
we are most proud, not of our low operating expenses or the billions of dollars
we manage, but of our sterling reputation created by the Vanguard crew.
We recognize that it is our crew members--more than 6,000 highly
motivated men and women--who form the cornerstone of our operations. As with
any cornerstone, we could not survive long--let alone prosper--without it.
That's why we chose this fiscal year's annual report to celebrate the spirit,
enthusiasm, and achievements of our crew. (We call those who work at Vanguard
crew members, not employees, because they operate as a team to accomplish our
mission of serving you, our clients.)
But while we prize the collective contributions of our crew, we also
take time to recognize the importance of the individual. Each calendar quarter,
we present our Award For Excellence to a handful of crew members who have
demonstrated particular excellence in the performance of their jobs and who
embody "The Vanguard Spirit." Our report cover shows only a few of the more
than 300 crew members who have received this distinction since 1984.
They, along with the rest of our valiant crew, look forward to serving
you in the years ahead.
[PHOTO] [PHOTO]
John C. Bogle John J. Brennan
Chairman President
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
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER,
Vanguard/PRIMECAP Fund rocketed ahead in 1997, providing a total
return of +36.8%--the best performance in the Fund's 13-year history.
PRIMECAP's remarkable results came during yet another extraordinary year for
the U.S. stock market, which capped a three-year run during which market
averages more than doubled.
Our Fund's return was an astonishing 11.5 percentage points higher
than that of its average peer and 3.4 percentage points higher than that of the
Standard & Poor's 500 Composite Stock Price Index. The table at right compares
the Fund's total return (capital change plus reinvested dividends) for the year
with that of the average growth mutual fund and the unmanaged S&P 500 Index,
which is dominated by large-capitalization blue chip stocks.
<TABLE>
<CAPTION>
- ----------------------------------------------------------
TOTAL RETURNS
YEAR ENDED
DECEMBER 31, 1997
- ----------------------------------------------------------
<S> <C>
Vanguard/PRIMECAP Fund +36.8%
- ----------------------------------------------------------
Average Growth Fund +25.3%
- ----------------------------------------------------------
S&P 500 Index +33.4%
- ----------------------------------------------------------
</TABLE>
The Fund's total return is based on net asset values of $30.08 per
share on December 31, 1996, and $39.56 per share on December 31, 1997, adjusted
for a dividend of $0.20 per share paid from net investment income and
distributions totaling $1.30 per share from net realized capital gains.
THE FINANCIAL MARKETS IN BRIEF
The historic bull market in U.S. stocks that began in August 1982 continued in
impressive fashion during 1997. The economy, corporate earnings, and employment
grew solidly and consumer confidence strengthened. Yet interest rates declined
and inflation decelerated. In short, the domestic economic news could not have
been better. The sole dark cloud--severe turmoil in Asian economies and
currencies--only briefly darkened Wall Street's mood. After a sharp decline in
October--the S&P 500 Index tumbled -7% on October 27 alone--stocks resumed
their climb, and the Index produced a +33.4% return for the year.
Long-term interest rates rose through the first quarter of the year on
expectations that the economy's robust growth would cause inflation to
accelerate. The yield on the benchmark 30-year U.S. Treasury bond peaked at
7.17% in mid-April. Then, as the news on inflation got better rather than
worse, the yield turned downward, falling to 5.92% on December 31, 72 basis
points below the 6.64% level at which it began the year.
Short-term interest rates bottomed out in June and began an irregular
climb that was apparently due to sales of short-term Treasuries by foreign
central banks and investors. At year-end 1997, the yield on three-month U.S.
Treasury bills was 5.35%, up just a bit from 5.17% when the year began. The
spread between yields on three-month T-bills and 30-year Treasury bonds was a
slim 0.57 percentage point on December 31, 1997. Such a "flattening" of the
yield curve has more often than not been a precursor of a slowing economy.
1997 PERFORMANCE OVERVIEW
The U.S. stock market, however, did anything but slow during the twelve months
ended December 31, and PRIMECAP rode the rising tide to its best year ever.
Though the
1
<PAGE> 4
reasons for our fine absolute and relative performance in 1997--and, indeed,
over the Fund's entire life span--are many, they boil down to stellar
investment management by our adviser, PRIMECAP Management Company. Our large
margin of superiority over the average growth mutual fund and the S&P 500 Index
during the year was due primarily to terrific stock selection nearly across the
board--particularly in the auto & transportation, health-care, and
producer-durables sectors.
Relative to our peers, our biggest strength was their weakness. While
PRIMECAP's mid- and small-cap stocks constituted 33% of assets, the average
comparable fund held fully 64% in these issues. In a large-cap year like 1997
(the return of the S&P 500 Index was 7.7 percentage points higher than the
+25.7% return of the rest of the U.S. stock market), this was a Herculean
handicap. PRIMECAP also achieved its fine relative performance in 1997--nearly
half again larger than our average peer's return of +25.3%--despite a
higher-than-average holding of cash, which acts as a drag on returns during a
rising stock market. Our cash position of 13% at year-end was at about twice
its normal level and was about twice the cash holdings of our average
competitor.
Our superiority over the S&P 500 Index, though considerably narrower,
also represents a significant accomplishment. Our fine stock selection was
especially evident in our airline and health-care holdings, which reflect
extraordinary gains averaging more than 60%. While we held a substantial
position in the weak producer-durables group, it was offset by good stock
picks. Our biggest negative was our large (29%) position in the lagging
technology group, in which our selections were not very good either.
The Index, of course, has built-in advantages over real-world mutual
funds, as it includes no cash and bears none of the expenses (operating and
transaction costs) that mutual funds incur. In addition, PRIMECAP owns stocks
that are, on average, smaller than those in the S&P 500 Index ($9.2 billion
median market capitalization for PRIMECAP; $34.1 billion for the Index), a
distinction that might otherwise have hurt our performance versus the Index,
given the market's large-cap bias during the year.
LONG-TERM PERFORMANCE OVERVIEW
Your Fund's record over the past decade has been truly remarkable, as shown in
the table below. It presents the average annual return for the past ten years
for PRIMECAP, our average competitor, and the S&P 500 Index, as well as the
ending value of hypothetical $10,000 investments in each, assuming the
reinvestment of income dividends and capital gains distributions. Based on our
+19.0% annual return, which is 3.6 percentage points higher than that of our
peers, a $10,000 investment in PRIMECAP would have grown over the decade to
$56,712, an amazing advantage of $14,797 over the $41,915 that would have
accumulated in the average growth fund. The difference is astounding--nearly 1
1/2 times the initial investment!
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
TOTAL RETURNS
10 YEARS ENDED DECEMBER 31, 1997
-----------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- ----------------------------------------------------------------------------
<S> <C> <C>
Vanguard/PRIMECAP Fund +19.0% $56,712
- ----------------------------------------------------------------------------
Average Growth Fund +15.4% $41,915
- ----------------------------------------------------------------------------
S&P 500 Index +18.1% $52,567
- ----------------------------------------------------------------------------
</TABLE>
In outperforming the S&P 500 Index by nearly 1 percentage point
annually over the decade, PRIMECAP amassed an advantage of $4,145 on the
hypothetical $10,000 investment.
2
<PAGE> 5
We should emphasize that our road to this fine performance record was
not without pitfalls. No mutual fund is without aberrations in its long-term
record. For example, we were beaten by the Index in 1987, 1988, and 1989, and
by our average peer in two of those three years (1987 and 1989). The point is
that the proper perspective for evaluating PRIMECAP--like any mutual fund
worthy of your consideration--should be the long-run.
Our low expenses provide our Fund with a head start over our
competitors, year after year. Our expense ratio (annual expenses as a
percentage of average net assets) is 0.51%--far less than the 1.50% expense
ratio of our average peer. We fully expect this advantage of roughly 1% to
persist, regardless of the direction of the financial markets. As mutual fund
investors are learning, however slowly, costs matter.
To help keep the extraordinary nature of the decade's returns in
perspective, we note that the ten-year period covered in this report excludes
the results of 1987--a year during which the S&P 500 Index shed 21.5% of its
value in a single month, and during which PRIMECAP's return was -2.3%. With
1987's return now "off the books" of our ten-year review--replaced by 1997's
+36.8% return--our Fund's average annual return over ten years is 4 percentage
points higher than it was in last year's report. We caution that there will
surely be individual down years ahead, and that returns from PRIMECAP, and from
the U.S. stock market in general, will almost certainly be less generous in
years to come.
IN SUMMARY
Returns from the U.S. stock market over the past three calendar years--indeed,
over the past 15 years--have no precedent in American financial history. While
as investors we have every reason to be grateful for the bounty of the
financial markets, we also have reason to regard the future with some caution.
Lengthy bull markets can breed complacency and cause investors to discount the
risks inherent in stocks. Make no mistake, the market will demonstrate these
risks from time to time.
However, the greatest risk is failure to invest in the first place. We
believe that the stock market's risks can be partially offset by holding a
balanced portfolio that includes not only stock funds, but also bond funds and
money market funds. Investors who maintain such portfolios allocated in
accordance with their time horizon, financial situation, and tolerance for
market volatility should be well prepared to "stay the course" toward their
investment objectives, no matter what the future has in store.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Chairman of the Board President
January 15, 1998
3
<PAGE> 6
THE MARKETS IN PERSPECTIVE
Year Ended December 31, 1997
U.S. EQUITY MARKETS
Despite some year-end rockiness, 1997 again provided U.S. equity investors with
exceptional returns, as illustrated by the 33.4% advance of the S&P 500 Index.
Investors' mettle was tested several times, however, and most severely by the
upheavals that devastated a number of Asian markets in the fourth quarter.
Beginning in late October, the U.S. market grew increasingly volatile, a direct
result of investors' struggle to understand the nature and implications of
Asia's economic turmoil. By the end of the year, it appeared that a new
consensus was emerging, grounded in two basic beliefs: (1) that the collapse of
currencies in the Far East would help keep inflation tame in the United States
and (2) that slower growth in Asia would most likely lead to weaker corporate
profits over the next several years.
As the dust continued to settle, many investors sought havens
traditional in periods of high uncertainty: large-capitalization issues and
particularly the "defensive" sectors of the stock market, such as utilities,
consumer staples, and health care. The closing weeks of 1997 saw a broad
advance in these "safe" sectors, with utilities gaining 20.1% and consumer
staples 10.4% in the last quarter. By contrast, more economically sensitive
sectors were thrashed in the wake of the Asian crisis, with technology issues
falling 12.3% and producer durables down 9.0% over the three months. After
posting strong results in the third quarter, small-company stocks also suffered
in the fourth, falling 3.3%.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED DECEMBER 31, 1997
-------------------------------
1 YEAR 3 YEARS 5 YEARS
- ----------------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 33.4% 31.2% 20.3%
Russell 2000 Index 22.4 22.3 16.4
MSCI EAFE Index 2.1 6.6 11.7
- ----------------------------------------------------------------------------
FIXED INCOME
Lehman Aggregate Bond Index 9.7% 10.4% 7.5%
Lehman 10-Year Municipal Bond Index 9.2 10.2 7.6
Salomon Brothers Three-Month
U.S. Treasury Bill Index 5.3 5.4 4.7
- ----------------------------------------------------------------------------
OTHER
Consumer Price Index 1.7% 2.5% 2.6%
- ----------------------------------------------------------------------------
</TABLE>
The year-end excitement did not detract from 1997's overall record as
a stellar year for U.S. stock investors. The best-performing sector was
financial services, which rose 46.9%. This sector benefited from a number of
factors, including the strength of the economy, the vibrant financial markets,
and merger activity. By contrast, the commodity-oriented materials & processing
sector posted a gain of "only" 12.3%--in itself more than a percentage point
above the long-term average return from common stocks. Small-cap stocks also
fared well overall, as illustrated by the 22.4% increase of the Russell 2000
Index. Small-company technology issues were the most glaring exception,
mustering a gain in 1997 of just 1.1%.
U.S. FIXED-INCOME MARKETS
In a year characterized by exceptionally low inflation, interest rates fell,
providing investors with very attractive total returns. The Lehman Aggregate
Bond Index, for example,
4
<PAGE> 7
posted a total return of 9.7% for 1997, comprising 7.2% in income return and
2.5% in capital appreciation. The decline in rates can be attributed largely to
better-than-expected reports about the inflation rate. Early in the year,
economists were projecting a 2.9% increase in the Consumer Price Index (CPI)
during 1997. In March, the Federal Reserve grew sufficiently concerned to boost
interest rates by 0.25% in an effort to temper economic growth and thereby ward
off inflation. By year-end, however, the worries seemed to have been
unnecessary, as the actual CPI increase was a mere 1.7%--its smallest increase
since 1986.
The bond market gradually gathered strength during the year as
investors grew more confident that four seemingly strange bedfellows--strong
economic growth, reasonable inflation, low unemployment, and stable wage
growth--would continue to coexist peacefully. In the fourth quarter, the market
also was bolstered by the "flight to quality" among investors concerned about
Asia's problems. Overall, the longest-maturity issues benefited most from the
decline in interest rates. The yield on the 30-year U.S. Treasury bond closed
the year at 5.92%, compared with 6.64% on December 31, 1996. Falling rates
flattened the yield curve considerably: Only 0.57% separated the yield on
Treasury bills from that on the 30-year issue, down from a spread of 1.47% at
the end of 1996.
The best-performing sector in 1997 was long-term Treasuries, as
illustrated by the 15.1% return of the Lehman Long U.S. Treasury Index.
Investors in lower-quality securities also fared well, with the Lehman High
Yield Bond Index generating a 12.8% gain. The strength of the economy, together
with the lack of inflationary pressure, created an ideal environment for junk
bonds.
INTERNATIONAL EQUITY MARKETS
Arguably, investors' greatest disappointments were in international
markets--and, of course, Asian markets in particular. During the year, the
Morgan Stanley Capital International (MSCI) Pacific Index declined by 25.7% in
U.S. dollar terms; the index fell 20.7% in the fourth quarter alone. Among
individual markets, the fiscal year saw sharp declines (in U.S. dollar terms)
in Japan, down 23.6% (including a 19.7% drop in the fourth quarter); Thailand,
down 76.8%; and Malaysia, down 68.1%. The general slump in Asian markets began
in midsummer with currency devaluations by a number of countries.
By contrast, the European markets continued to provide U.S. investors
with solid returns, although they, too, stumbled in late October and
subsequently recovered. The MSCI Europe Index posted a gain of 23.7% for the 12
months. The robust character of the European markets reflected strong corporate
earnings and optimism that the European Monetary Union would provide a solid
framework for future fiscal responsibility and economic growth.
5
<PAGE> 8
REPORT FROM THE ADVISER
During 1997, Vanguard/PRIMECAP Fund's total return of 36.8% exceeded
the 33.4% recorded by the unmanaged S&P 500 Index and the 25.3% achieved by the
average growth mutual fund.
We are especially pleased to report these results, given how
challenging the year proved to be for growth fund managers. According to
Lipper Analytical Services, less than 9% of growth funds managed to surpass the
total return of the S&P 500 Index. Our relative outperformance was produced
despite a significant underweighting in financial-services stocks, whose 47%
return was by far the strongest of any market sector.
In our semiannual report, we discussed the important role stock
selection played in our first-half results. This was also true for the full
year's results. As shown in the adjacent table, the Fund's ten largest holdings
(as of January 1, 1997) appreciated an average of 50.5% during the year. This
is particularly satisfying to us because individual stock selection is our
primary focus and is, we believe, where we most add value as managers.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
PERFORMANCE OF LAST YEAR'S TEN LARGEST HOLDINGS
- -----------------------------------------------------------------
% OF ASSETS 1997
SECURITY JAN. 1, 1997 RETURN
- -----------------------------------------------------------------
<S> <C> <C>
Intel Corp. 6.0% 7.5%
Federal Express Corp. 4.4 37.2
Texas Instruments, Inc. 4.4 42.2
AMR Corp. 3.9 45.8
Guidant Corp. 3.5 118.6
Delta Air Lines, Inc. 3.4 68.2
LM Ericsson Telephone Co. 3.4 24.5
Motorola, Inc. 2.5 -5.9
American International
Group, Inc. 2.4 51.1
Tandem Computers, Inc. 2.3 115.7
- -----------------------------------------------------------------
Combined 36.2% 50.5%
- -----------------------------------------------------------------
</TABLE>
Looking at the year in its entirety, our holdings in the
transportation and health-care sectors accounted for most of our favorable
relative performance. In our 1996 annual report, we wrote extensively about the
improving fundamentals in the airline industry. We noted that traffic, load
factors, and yields were firming concurrent with slower growth in capacity and
aggressive cost-containment efforts. We argued that barriers to entry were
emerging. Unfortunately, these positive developments had been overshadowed in
1996 by a few extraordinary events, including the TWA Flight 800 tragedy, the
reinstatement of the excise tax on airline tickets, and a sharp rise in oil
prices. Consequently, the airline stocks fared poorly in 1996, and they
continued to depress our results through the first half of 1997. Throughout
this period, however, the industry's fundamentals not only remained intact but
continued to improve. By the end of 1997, the significant improvement in the
prospects of the airline industry began to be reflected in share prices. For
the year, Delta Air Lines, AMR Corp., and Southwest Airlines appreciated 68%,
46%, and 68%, respectively. Despite these gains, we still view airline stocks
as compelling values, and believe that investors have only begun to recognize
how dramatically this industry has changed. Consequently, we continue to
substantially overweight this group.
Our transportation stocks, which as a group gained 61%, were also
buoyed by a strong showing in stocks of
6
<PAGE> 9
air freight companies. Airborne Freight jumped 167%, and Federal Express gained
37%. Strong growth in unit volume, new distance-based pricing policies, and the
labor dispute that disrupted business at UPS all contributed to impressive
earnings growth and an improving outlook for our holdings. In the first week of
1998, Federal Express increased rates by 3%-4%, the first across-the-board
increase in more than four years. This action supports our contention that the
industry's profitability could improve.
The outstanding performance of our health-care holdings was also
integral to the Fund's excellent performance in 1997. We avoided the HMO and
biotech stocks, and focused on the medical device and pharmaceutical areas. Our
selections appreciated 69%, led by Guidant (up 119%) and Eli Lilly (up 93%).
Considering only our semiannual and annual results, one would see an
incomplete picture of how the year evolved for the Fund. Relative performance
in the two periods was fairly similar. In the first half of the year, the Fund
outperformed the S&P 500 Index by about 0.5 percentage point. In the second
half, the Fund outperformed the Index by about 2.5 percentage points. However,
between June 30 and December 31, the Fund experienced considerable
volatility--more than we cared for. In the third quarter, our performance was
exceptional, up 19.7% versus 7.5% for the S&P 500 Index. Our top ten holdings
returned more than 30% on average. Similarly, our technology holdings surged
more than 30%.
The fourth quarter brought an abrupt reversal to the extraordinary
third-quarter performance. The collapse of currencies and stock markets across
Southeast Asia prompted investors to seek out safe stocks with limited or no
exposure to the Far East. Our technology and producer-durables stocks were
crushed, declining 21.5% and 11.3%, respectively. Conversely, the utility
sector, which had been the worst sector of the market for the past several
years and where the Fund had virtually no exposure, surged (returning 20% for
the quarter). Consumer staples also rallied, climbing 10%.
We believe the fourth-quarter pummeling of the Fund's technology and
producer-durables shares was an overreaction to the events in Southeast Asia.
The region represents a small percentage of most companies' revenue.
Furthermore, many companies either buy products or maintain manufacturing
operations in the region, so lower costs should offset potential revenue
declines. Additionally, the exclusive focus on events in Southeast Asia has
caused investors to overlook both a clearly improving European economy and the
possibility of Japan's emergence from its long-standing economic malaise. The
European and Japanese markets have considerably greater impact on the fortunes
of the Fund's holdings than does Southeast Asia.
We approach 1998 with greater caution than we have felt in some time.
The S&P 500 Index has produced a cumulative total return of 125.6% during the
past three years. Valuations have certainly increased. Moreover, the turmoil in
Asian economies and markets will continue to impact U.S. stocks. Consequently,
we have increased the Fund's cash position to 13%, an unusually high level.
Howard B. Schow, Portfolio Manager Theo A. Kolokotrones, Portfolio Manager
Joel P. Fried, Assistant Portfolio Manager
PRIMECAP Management Company
January 14, 1998
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.
7
<PAGE> 10
PORTFOLIO PROFILE
PRIMECAP Fund
This Profile provides a snapshot of the Fund's characteristics as of December
31, 1997, 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 99 500
Median Market Cap $9.2B $34.1B
Price/Earnings Ratio 18.7x 21.9x
Price/Book Ratio 3.6x 4.1x
Yield 0.9% 1.6%
Return on Equity 16.1% 20.4%
Earnings Growth Rate 22.2% 17.6%
Foreign Holdings 7.1% 1.9%
Turnover Rate 13% --
Expense Ratio 0.51% --
Cash Reserves 13.0% --
</TABLE>
INVESTMENT FOCUS
- --------------------------------------------------------------
[GRAPH]
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- --------------------------------------------------------------
PRIMECAP S&P 500
- --------------------------------------------------------------
<S> <C> <C>
R-Squared 0.62 1.00
Beta 0.99 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- --------------------------------------------------------------
<S> <C>
Delta Air Lines, Inc. 4.1%
AMR Corp. 4.0
Guidant Corp. 4.0
Texas Instruments, Inc. 3.7
Intel Corp. 3.2
Federal Express Corp. 3.2
Pharmacia & Upjohn, Inc. 2.7
Adobe Systems, Inc. 2.6
LM Ericsson Telephone Co. 2.1
Hewlett-Packard Co. 2.0
- --------------------------------------------------------------
Top Ten 31.6%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCK)
- ------------------------------------------------------------------------------------
DECEMBER 31, 1996 DECEMBER 31, 1997
-------------------------------------------
PRIMECAP PRIMECAP S&P 500
-------------------------------------------
<S> <C> <C> <C>
Auto & Transportation . . . . . . . . 15.8% 17.1% 3.5%
Consumer Discretionary . . . . . . . . 8.0 8.0 9.8
Consumer Staples . . . . . . . . . . . 1.8 1.7 11.5
Financial Services . . . . . . . . . . 11.4 6.5 17.7
Health Care . . . . . . . . . . . . . 10.6 12.3 11.4
Integrated Oils . . . . . . . . . . . 0.0 0.0 7.2
Other Energy . . . . . . . . . . . . . 0.2 1.0 1.4
Materials & Processing . . . . . . . . 6.6 7.9 5.8
Producer Durables . . . . . . . . . . 10.7 10.0 4.0
Technology . . . . . . . . . . . . . . 34.5 29.2 11.2
Utilities . . . . . . . . . . . . . . 0.4 0.4 10.6
Other . . . . . . . . . . . . . . . . 0.0 5.9 5.9
- ------------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 11
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned 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%.
CASH RESERVES. The percentage of a portfolio's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing securities. This
figure does not include cash invested in futures contracts to simulate stock
investment.
EARNINGS GROWTH RATE. The average annual 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.
FOREIGN HOLDINGS. The percentage of a portfolio's net assets represented by
stocks or American Depositary Receipts 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.
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.
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 whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a portfolio's common stocks that
come from each of the major industry groups that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of net assets that a portfolio has
invested in its ten largest holdings. (The average for stock mutual funds is
about 30%.) As this percentage rises, a portfolio's returns are likely to be
more volatile, because they are 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 distribute capital gains (which are taxable to investors).
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. The index yield is based on the current annualized rate of
dividends paid on stocks in the index.
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 an investment in the Fund
could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: NOVEMBER 1, 1984-DECEMBER 31, 1997
- ------------------------------------------------------------------------------------
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
1997 36.1 0.7 36.8 33.4
- -----------------------------------------------------------------------------------
</TABLE>
See Financial Highlights table on page 15 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: DECEMBER 31, 1987-DECEMBER 31, 1997
- ------------------------------------------------------------------------------------------------
PRIMECAP FUND AVERAGE GROWTH FUND S&P 500 INDEX
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
198712 10000 10000 10000
198803 11268 10750 10569
198806 11924 11363 11273
198809 11507 11247 11312
198812 11466 11396 11661
198903 12179 12207 12488
198906 12912 13175 13590
198909 14092 14502 15045
198912 13944 14295 15356
199003 14055 13979 14894
199006 15132 14980 15831
199009 11869 12567 13655
199012 13554 13512 14879
199103 16696 15879 17040
199106 16185 15738 17001
199109 16797 16929 17910
199112 18047 18388 19412
199203 17894 18168 18922
199206 17377 17630 19282
199209 17555 18191 19890
199212 19670 19821 20891
199303 20680 20325 21803
199306 21216 20463 21910
199309 22339 21458 22476
199312 23216 21920 22997
199403 23135 21095 22125
199406 23325 20662 22218
199409 25311 21762 23304
199412 25865 21448 23300
199503 28443 22954 25569
199506 32405 25259 28010
199509 35171 27392 30236
199512 35043 28054 32056
199603 36233 29452 33777
199606 38058 30867 35293
199609 38689 31745 36384
199612 41459 33452 39416
199703 43425 32913 40473
199706 50198 38262 47539
199709 60102 42386 51099
199712 56712 41915 52567
- ------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1997
------------------------------------------ FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
PRIMECAP Fund 36.79% 23.59% 18.95% $56,712
Average Growth Fund 25.30 16.16 15.41 41,915
S&P 500 Index 33.36 20.27 18.05 52,567
- --------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION ----------------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
PRIMECAP Fund 11/1/1984 36.79% 23.59% 18.03% 0.92% 18.95%
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
FINANCIAL STATEMENTS
December 31, 1997
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)
- ------------------------------------------------------------------------------------------------------------
COMMON STOCKS (87.0%)
- ------------------------------------------------------------------------------------------------------------
AUTO & TRANSPORTATION (14.9%)
<S> <C> <C>
- - AMR Corp. 2,550,000 $ 327,675
(1) Airborne Freight Corp. 1,580,000 98,157
Arvin Industries, Inc. 700,000 23,319
Delta Air Lines, Inc. 2,850,000 339,150
- - Federal Express Corp. 4,300,000 262,569
Fleetwood Enterprises, Inc. 600,000 25,462
Southwest Airlines Co. 5,775,000 142,209
------------
1,218,541
------------
CONSUMER DISCRETIONARY (7.0%)
- - Costco Cos., Inc. 3,500,000 155,969
- - Electronic Arts Inc. 1,500,000 56,719
- - Filene's Basement Corp. 995,000 3,980
- - GC Cos. 200,000 9,475
Harcourt General, Inc. 1,500,000 82,125
Manpower Inc. 1,370,000 48,292
McClatchy Newspapers, Inc. 760,700 20,681
- -(1) Neiman-Marcus Group Inc. 3,000,000 90,750
- -(1) Plantronics, Inc. 1,608,000 64,320
Time Warner, Inc. 600,000 37,200
------------
569,511
------------
CONSUMER STAPLES (1.4%)
Block Drug Co. Class A 200,000 8,500
Brown-Forman Corp. Class B 411,800 22,752
The Seagram Co. Ltd. 2,700,600 87,263
------------
118,515
------------
ENERGY (0.9%)
Union Pacific Resources
Group, Inc. 2,955,000 71,659
------------
FINANCIAL SERVICES (5.6%)
American International
Group, Inc. 836,924 91,015
City National Corp. 621,485 22,956
General Re Corp. 620,000 131,440
HSB Group Inc. 200,000 11,037
Marsh & McLennan Cos., Inc. 380,000 28,334
Reuters Holdings PLC ADR 35,000 2,310
St. Paul Cos., Inc. 100,000 8,206
State Street Corp. 1,440,000 83,790
Torchmark Corp. 970,000 40,801
Transatlantic Holdings, Inc. 562,500 40,219
------------
460,108
------------
HEALTH CARE (10.7%)
- - Boston Scientific Corp. 355,000 16,286
Guidant Corp. 5,210,632 324,362
Johnson & Johnson 1,100,000 72,462
Eli Lilly & Co. 1,960,000 136,465
- - Lynx Therapeutics Inc. 72,900 1,185
Medtronic, Inc. 1,996,888 104,462
Pharmacia & Upjohn, Inc. 6,100,000 223,412
------------
878,634
------------
MATERIALS & PROCESSING (6.9%)
Belden, Inc. 383,000 13,501
Engelhard Corp. 4,000,000 69,500
(1) Granite Construction Co. 1,400,000 32,200
(1) MacDermid, Inc. 567,000 45,998
Monsanto Co. 2,700,000 113,400
- - Mycogen Corp. 1,400,000 26,250
OM Group, Inc. 500,000 18,313
Pioneer Hi-Bred
International, Inc. 450,000 48,263
Potash Corp. of
Saskatchewan, Inc. 1,460,000 121,180
</TABLE>
11
<PAGE> 14
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
MARKET
VALUE*
PRIMECAP FUND SHARES (000)
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Stepan Co. 300,000 $ 8,888
Temple-Inland Inc. 1,300,000 68,006
------------
565,499
------------
PRODUCER DURABLES (8.7%)
AMP, Inc. 375,000 15,750
Caterpillar, Inc. 1,810,000 87,898
Deere & Co. 600,000 34,988
- - Dionex Corp. 510,000 25,245
Donaldson Co., Inc. 540,000 24,334
Flowserve Corp. 908,852 25,391
Kennametal, Inc. 1,140,000 59,066
- - Lexmark International
Group, Inc. Class A 400,000 15,200
(1) Millipore Corp. 2,500,000 84,844
Molex, Inc. 195,312 6,250
Molex, Inc. Class A 195,312 5,615
Perkin-Elmer Corp. 1,300,000 92,381
Pitney Bowes, Inc. 1,200,000 107,925
(1) Tektronix, Inc. 3,285,000 130,373
------------
715,260
------------
TECHNOLOGY (25.4%)
COMMUNICATIONS TECHNOLOGY (4.7%)
LM Ericsson Telephone Co.
ADR Class B 4,600,000 171,638
LM Ericsson Telephone Co.
4.25% Cvt. Pfd. 620 3,255
Lucent Technologies, Inc. 150,000 11,981
Motorola, Inc. 2,030,000 115,837
- - Netscape Communications
Corp. 26,670 647
- - Tellabs, Inc. 1,600,000 84,300
COMPUTER SERVICES, SOFTWARE & SYSTEMS (3.4%)
(1) Adobe Systems, Inc. 5,190,000 213,439
- -(1) The SABRE Group
Holdings, Inc. 2,289,200 66,101
- - Siebel Systems, Inc. 17,298 723
- - Tripos Inc. 100,000 1,425
COMPUTER TECHNOLOGY (7.1%)
- - Bay Networks, Inc. 3,870,000 98,927
Compaq Computer Corp. 2,199,750 124,148
- - Digital Equipment Corp. 4,040,000 149,480
- -(1) Evans & Sutherland
Computer Corp. 840,000 24,360
Hewlett-Packard Co. 2,680,000 167,500
- - Stratus Computer, Inc. 377,000 14,255
ELECTRONICS (1.5%)
Nokia Corp. A ADR 480,000 33,600
Sony Corp. ADR 965,000 87,574
ELECTRONICS--SEMICONDUCTORS/COMPONENTS (7.7%)
Intel Corp. 3,768,000 264,467
- - LSI Logic Corp. 1,488,700 29,402
Texas Instruments, Inc. 6,680,000 300,600
- - Xilinx, Inc. 1,000,000 35,000
ELECTRONICS--TECHNOLOGY (1.0%)
- - Coherent, Inc. 500,000 17,500
Symbol Technologies, Inc. 1,666,500 62,910
------------
2,079,069
------------
UTILITIES (0.4%)
- - Tejas Gas Corp. 500,000 30,625
------------
OTHER (5.1%)
Novartis AG ADR 850,000 69,063
Miscellaneous (4.2%) 347,490
------------
416,553
------------
- ------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $4,347,657) 7,123,974
- ------------------------------------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (13.5%)
- ------------------------------------------------------------------------------------------------------------
<CAPTION>
FACE
AMOUNT
(000)
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
6.54%, 1/2/1998 $1,086,469 1,086,469
6.50%, 1/2/1998--Note F 16,701 16,701
- ------------------------------------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $1,103,170) 1,103,170
- ------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (100.5%)
(COST $5,450,827) 8,227,144
- ------------------------------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.5%)
- ------------------------------------------------------------------------------------------------------------
Other Assets--Note C 42,394
Liabilities--Note F (83,375)
-----------
(40,981)
- ------------------------------------------------------------------------------------------------------------
NET ASSETS (100%)
- ------------------------------------------------------------------------------------------------------------
Applicable to 206,907,610 outstanding
$.001 par value shares
(authorized 400,000,000 shares) $8,186,163
============================================================================================================
NET ASSET VALUE PER SHARE $39.56
============================================================================================================
*See Note A in Notes to Financial Statements.
- -Non-Income-Producing Security.
ADR--American Depositary Receipt.
(1)Considered an affiliated company as the Fund owns
more than 5% of the outstanding voting securities of
such company. The total market value of investments in
affiliated companies was $850,542,000.
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 1997, NET ASSETS CONSISTED OF:
- ------------------------------------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $5,345,063 $25.83
Undistributed Net
Investment Income 444 --
Accumulated Net
Realized Gains 64,339 .31
Unrealized Appreciation--
Note E 2,776,317 13.42
- ------------------------------------------------------------------------------------------------------------
NET ASSETS $8,186,163 $39.56
============================================================================================================
</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, 1997
(000)
- -------------------------------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends* $ 39,758
Interest 33,159
-------------
Total Income 72,917
-------------
EXPENSES
Investment Advisory Fees--Note B 14,455
The Vanguard Group--Note C
Management and Administrative 14,527
Marketing and Distribution 1,192
Taxes (other than income taxes) 446
Custodian Fees 18
Auditing Fees 12
Shareholders' Reports 177
Annual Meeting and Proxy Costs 71
Directors' Fees and Expenses 14
-------------
Total Expenses 30,912
- -------------------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME 42,005
- -------------------------------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD* 289,401
- -------------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 1,327,647
- -------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $1,659,053
=============================================================================================================
</TABLE>
*Dividend income and realized gain from affiliated companies were $5,461,000
and $135,180,000, respectively.
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
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,
-----------------------------------
1997 1996
(000) (000)
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 42,005 $ 25,594
Realized Net Gain 289,401 106,160
Change in Unrealized Appreciation (Depreciation) 1,327,647 505,864
-----------------------------------
Net Increase in Net Assets Resulting from Operations 1,659,053 637,618
-----------------------------------
DISTRIBUTIONS
Net Investment Income (39,529) (27,258)
Realized Capital Gain (248,608) (98,658)
-----------------------------------
Total Distributions (288,137) (125,916)
-----------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 3,307,320 994,160
Issued in Lieu of Cash Distributions 282,274 124,436
Redeemed (978,333) (663,154)
-----------------------------------
Net Increase from Capital Share Transactions 2,611,261 455,442
- --------------------------------------------------------------------------------------------------------------
Total Increase 3,982,177 967,144
- --------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 4,203,986 3,236,842
-----------------------------------
End of Year $8,186,163 $4,203,986
==============================================================================================================
(1)Shares Issued (Redeemed)
Issued 85,932 35,931
Issued in Lieu of Cash Distributions 7,480 4,217
Redeemed (26,285) (23,764)
-----------------------------------
Net Increase in Shares Outstanding 67,127 16,384
==============================================================================================================
</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 Securities and Exchange Commission
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 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $30.08 $26.23 $19.98 $18.42 $16.19
- ---------------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .21 .19 .22 .12 .07
Net Realized and Unrealized Gain (Loss) on Investments 10.77 4.59 6.84 1.97 2.82
------------------------------------------------------
Total from Investment Operations 10.98 4.78 7.06 2.09 2.89
------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.20) (.20) (.22) (.12) (.07)
Distributions from Realized Capital Gains (1.30) (.73) (.59) (.41) (.59)
------------------------------------------------------
Total Distributions (1.50) (.93) (.81) (.53) (.66)
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $39.56 $30.08 $26.23 $19.98 $18.42
=================================================================================================================================
TOTAL RETURN 36.79% 18.31% 35.48% 11.41% 18.03%
=================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $8,186 $4,204 $3,237 $1,554 $791
Ratio of Total Expenses to Average Net Assets 0.51% 0.59% 0.58% 0.64% 0.67%
Ratio of Net Investment Income to Average Net Assets 0.69% 0.69% 0.99% 0.79% 0.44%
Portfolio Turnover Rate 13% 10% 7% 8% 16%
Average Commission Rate Paid $.0599 $.0637 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. PRIMECAP Management provides investment advisory services to the Fund for
a fee calculated at an annual percentage rate of average net assets. For the
year ended December 31, 1997, the advisory fee represented an effective annual
rate of 0.24% of the Fund's average net assets after giving effect to a fee
waiver of $1,238,000 (0.02%) for the period April 1, 1997, to September 30,
1997.
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,
1997, the Fund had contributed capital of $536,000 to Vanguard (included in
Other Assets), representing 2.7% of Vanguard's capitalization. The Fund's
Directors and officers are also Directors and officers of Vanguard.
D. During the year ended December 31, 1997, the Fund purchased $2,300,644,000
of investment securities and sold $718,205,000 of investment securities, other
than temporary cash investments.
E. At December 31, 1997, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $2,776,317,000,
consisting of unrealized gains of $2,863,466,000 on securities that had risen
in value since their purchase and $87,149,000 in unrealized losses on
securities that had fallen in value since their purchase.
F. The market value of securities on loan to brokers/dealers at December 31,
1997, was $16,554,000, for which the Fund held cash collateral of $16,701,000.
Cash collateral received is invested in repurchase agreements.
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, 1997, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended and the financial highlights for each of
the five years in the period then ended, 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, 1997 by correspondence with the
custodian and the application of alternative auditing procedures where
securities purchased had not been settled, provide a reasonable basis for the
opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
February 6, 1998
17
<PAGE> 20
SPECIAL 1997 TAX INFORMATION (UNAUDITED) FOR VANGUARD/PRIMECAP FUND
This information for the fiscal year ended December 31, 1997, is included
pursuant to provisions of the Internal Revenue Code.
The Fund designates $211,834,000 as capital gain dividends (from net
long-term capital gains), of which $151,006,000 was distributed to shareholders
in December 1997 and $60,828,000 will be distributed in March 1998. Of the
$211,834,000 capital gain dividends, the Fund designates $179,279,000 as a 20%
rate gain distribution.
For corporate shareholders, 28.7% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
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.; Managing Director
of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun
Company, Inc., and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions,
Inc., Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance
Co., and Ladies Professional Golf Association; Trustee Emerita of Wellesley
College.
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 Telecommunications 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. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director 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
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DISTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MACKINNON
Managing Director, Fixed Income Group.
F. WILLIAM MCNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"Standard & Poor's 500," "S&P 500(R)," "Standard & Poor's(R)," "S&P(R)," and
"500" are trademarks of The McGraw-Hill Companies, Inc. Frank Russell
Company is the owner of trademarks and copyrights relating to the
Russell Indexes. "Wilshire 4500" and "Wilshire 5000" are
trademarks of Wilshire Associates.
<PAGE> 22
VANGUARD FAMILY OF FUNDS
STOCK FUNDS
Convertible Securities Fund
Equity Income Fund
Explorer Fund
Growth and Income Portfolio
Horizon Fund
Aggressive Growth Portfolio
Capital Opportunity Portfolio
Global Equity Portfolio
Index Trust
500 Portfolio
Extended Market Portfolio
Growth Portfolio
Small Capitalization Stock
Portfolio
Total Stock Market Portfolio
Value Portfolio
Institutional Index Fund
International Equity Index Fund
Emerging Markets Portfolio
European Portfolio
Pacific Portfolio
International Growth Portfolio
International Value Portfolio
Morgan Growth Fund
PRIMECAP Fund
Selected Value Portfolio
Specialized Portfolios
Energy Portfolio
Gold & Precious Metals
Portfolio
Health Care Portfolio
REIT Index Portfolio
Utilities Income Portfolio
Tax-Managed Fund
Capital Appreciation
Portfolio
Growth and Income Portfolio
Total International Portfolio
Trustees' Equity Fund
U.S. Portfolio
U.S. Growth Portfolio
Windsor Fund
Windsor II
BALANCED FUNDS
Asset Allocation Fund
Balanced Index Fund
Horizon Fund
Global Asset Allocation
Portfolio
LifeStrategy Portfolios
Conservative Growth
Portfolio
Growth Portfolio
Income Portfolio
Moderate Growth Portfolio
STAR Portfolio
Tax-Managed Fund
Balanced Portfolio
Wellesley Income Fund
Wellington Fund
BOND FUNDS
Admiral Funds
Intermediate-Term U.S.
Treasury Portfolio
Long-Term U.S. Treasury
Portfolio
Short-Term U.S. Treasury
Portfolio
Bond Index Fund
Intermediate-Term Bond
Portfolio
Long-Term Bond Portfolio
Short-Term Bond Portfolio
Total Bond Market Portfolio
Fixed Income Securities Fund
GNMA Portfolio
High Yield Corporate Portfolio
Intermediate-Term Corporate
Portfolio
Intermediate-Term U.S.
Treasury Portfolio
Long-Term Corporate
Portfolio
Long-Term U.S. Treasury
Portfolio
Short-Term Corporate
Portfolio
Short-Term Federal Portfolio
Short-Term U.S. Treasury
Portfolio
Municipal Bond Fund
High-Yield Portfolio
Insured Long-Term Portfolio
Intermediate-Term Portfolio
Limited-Term Portfolio
Long-Term Portfolio
Short-Term Portfolio
Preferred Stock Fund
State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
MONEY MARKET FUNDS
Admiral Funds
U.S. Treasury Money Market
Portfolio
Money Market Reserves
Federal Portfolio
Prime Portfolio
Municipal Bond Fund
Money Market Portfolio
Treasury Money Market Portfolio
State Tax-Free Funds
(CA, NJ, NY, OH, PA)
Q590-12/1997
(C) 1998 Vanguard Marketing
Corporation, Distributor
[THE VANGUARD GROUP LOGO]
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
www.vanguard.com
[email protected]
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 you invest or send money. Prospectuses can
be obtained directly from The Vanguard Group.
