<PAGE> 1
VANGUARD
PRIMECAP FUND
[PHOTO]
ANNUAL
REPORT
DECEMBER 31, 1998
[THE VANGUARD GROUP LOGO]
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AT VANGUARD, WE BELIEVE THAT TRADITION MATTERS
Our 8,000 crew members embrace the traditional values on which our success is
built, including integrity, hard work, thrift, teamwork, and fair dealing on
behalf of our clients.
This year, our report cover pays homage to three anniversaries, each of great
significance to The Vanguard Group:
- - The 200th anniversary of the Battle of the Nile, which commenced on August 1,
1798. HMS Vanguard, the victorious British flagship at the Nile, is our
namesake. And its motto--"Leading the way"--serves as a guiding principle for
our company.
- - The 100th birthday, on July 23, of Walter L. Morgan, founder of Wellington
Fund, the oldest member of what became The Vanguard Group. Mr. Morgan was
friend and mentor to Vanguard founder John C. Bogle, and helped to shape the
standards and business principles that Mr. Bogle laid down for Vanguard at its
beginning nearly 25 years ago: a stress on balanced, diversified investments;
insistence on fair dealing and candor with clients; and a focus on long-term
investing. To our great regret, Mr. Morgan died on September 2.
- - The 70th anniversary, on December 28, of the incorporation of Vanguard
Wellington Fund. It is the nation's oldest balanced mutual fund, and one of
only a handful of funds created in the 1920s that are still in operation.
Although Vanguard constantly tackles new challenges, adopts new technology, and
develops new services, we treasure the traditions and values that set us apart
in a crowded, competitive industry. And we salute our shareholders, whose
support and trust we strive to earn each and every day.
[PHOTO]
CONTENTS
A MESSAGE TO
OUR SHAREHOLDERS
1
THE MARKETS IN
PERSPECTIVE
4
REPORT FROM
THE ADVISER
6
FUND PROFILE
8
PERFORMANCE SUMMARY
10
FINANCIAL STATEMENTS
11
REPORT OF
INDEPENDENT ACCOUNTANTS
17
All comparative mutual fund data
are from Lipper or Morningstar,
unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER,
[PHOTO] [PHOTO]
JOHN J. BRENNAN JOHN C. BOGLE
CHAIRMAN & CEO SENIOR CHAIRMAN
Vanguard PRIMECAP Fund earned +25.4% during 1998, a year when the stock market
encountered considerable turbulence en route to yet another strong performance.
For the year, our return was comfortably ahead of that achieved by the average
growth mutual fund. However, we fell short of our index benchmark during a year
when a relative handful of funds (only 17% of general equity funds) matched the
remarkable performance of the unmanaged Standard & Poor's 500 Composite Stock
Price Index.
<TABLE>
<CAPTION>
- -------------------------------------------------
TOTAL RETURNS
YEAR ENDED
DECEMBER 31, 1998
- -------------------------------------------------
<S> <C>
Vanguard PRIMECAP Fund +25.4%
- -------------------------------------------------
Average Growth Fund +22.9%
- -------------------------------------------------
S&P 500 Index +28.6%
- -------------------------------------------------
</TABLE>
The table at right presents the 1998 total returns (capital change plus
reinvested dividends) of PRIMECAP, our average peer, and the S&P 500 Index. The
fund's return is based on an increase in net asset value from $39.56 per share
on December 31, 1997, to $47.66 per share on December 31, 1998, adjusted for
dividends totaling $0.35 per share paid from net investment income and
distributions totaling $1.52 per share paid from net realized capital gains.
FINANCIAL MARKETS IN REVIEW
The U.S. economy grew at a robust pace--more than 3%--during 1998 as it shrugged
off the effects of serious financial problems in Asia, Russia, and Latin
America. Troubles abroad slowed demand for American exports and boosted demand
for imported goods, widening the U.S. trade deficit. But the domestic economy
got a powerful push from higher consumer spending, which was encouraged by low
unemployment (4.3% at year-end) and higher wages (up about 4%, well above the
1.6% inflation rate).
The optimism that kept shopping malls and automobile showrooms busy was also
a factor in the financial markets. Stock prices shot up during the first half of
the year, although corporate earnings dipped slightly, and by July 17 the S&P
500 Index had gained +23.3%. But fears that Asia's financial troubles were
spreading worldwide touched off a sharp decline: Over the next six weeks, the
S&P 500 Index fell -19.2%. Declines were even steeper for smaller stocks: The
Russell 2000 Index of small-capitalization stocks fell nearly -40% from its
mid-April peak to its low in October.
The stock market then revived with remarkable speed and vigor. By year-end,
the S&P 500 Index was again in record territory, having gained +28.6% for the
year. This result, however, masked weakness elsewhere in the market. The
Wilshire 4500 Equity Index, which comprises all U.S. common stocks not included
in the S&P 500, gained just +8.6%, while the Russell 2000 Index declined -2.5%.
In all, more stocks declined in price than rose. Among large-cap stocks, there
was a huge gap between returns on growth and value stocks: The S&P 500's growth
component gained +42.2% during the year, nearly three times the +14.7% return on
its value stocks.
Interest rates declined on balance during 1998. Bond prices, which move in
the opposite direction from rates, generally rose. Price appreciation accounted
for 2 percentage
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points of the +8.7% total return of the Lehman Brothers Aggregate Bond Index.
Rates fell furthest--roughly 1 percentage point--for U.S. Treasury securities,
which benefited from a "flight to quality" as many investors shunned riskier
securities.
1998 PERFORMANCE OVERVIEW
A particularly strong second-half performance led PRIMECAP Fund to a +25.4%
return in 1998, outpacing the return of the average growth fund by 2.5
percentage points. However, we fell 3.2 percentage points behind the +28.6%
return of the S&P 500 Index.
Our margin over competitors was due largely to the stock selections of our
adviser, PRIMECAP Management Company. PRIMECAP Management's disciplined approach
to choosing stocks often leads to a portfolio that differs considerably in
industry weightings from those of other funds or of the S&P 500 Index. For
example, during the year we held five times the index weighting in
transportation stocks (about 17% versus 3%), double the index weighting in
technology issues (29% versus 13%), while holding no stocks from the utilities
and integrated oils sectors, which account for about 11% and 7%, respectively,
of the S&P 500 Index. Such differences are why our returns often differ from
these benchmarks. While our first-half return trailed that of both the average
growth fund (by 3.2 percentage points) and the S&P 500 (by 5.8 percentage
points), during the latter half of the year we solidly outpaced both our average
peer and the index.
We fell short of the index for the year for two main reasons: the wide split
between large-cap and small-cap stock returns and the fund's sizable cash
holdings. The 50 largest stocks in the S&P 500, representing 55% of the index's
market value, gained more than 40% in 1998, while the U.S. stock market as a
whole gained +23.4%. Having only about 13% of PRIMECAP Fund's assets in the 50
behemoth stocks proved to be a disadvantage in a "bigger is better" year.
Our worst-performing group in comparison with the index was auto &
transportation stocks, principally airline issues. This group earned only about
+5% for the fund, versus +22% for the transportation stocks in the index. On the
other hand, our performance was aided by a large stake in technology stocks,
which accounted for about 29% of assets during the year, more than twice the
index weighting. Our stocks in this sector, although earning more than +57% for
the year, trailed the average +83% gain of the index's tech stocks, led by
Microsoft (+115%), Intel (+69%), IBM (+77%), and Cisco Systems (+150%)--four of
the ten largest stocks in the index.
For much of the year, PRIMECAP Fund's cash holdings exceeded 10% of its
assets, although by year-end cash was down to about 6% of assets. In such a
powerful stock market as we experienced during 1998, cash retards a fund's
return.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
TOTAL RETURNS
10 YEARS ENDED
DECEMBER 31, 1998
-----------------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- ---------------------------------------------------------------------
<S> <C> <C>
Vanguard PRIMECAP Fund +20.0% $62,048
- ---------------------------------------------------------------------
Average Growth Fund +16.3% $45,189
- ---------------------------------------------------------------------
S&P 500 Index +19.2% $57,963
- ---------------------------------------------------------------------
</TABLE>
LONG-TERM PERFORMANCE OVERVIEW
Vanguard PRIMECAP Fund's long-term record is, in a word, admirable. Our return
over the past decade exceeded that of both our average peer and the S&P 500
Index, as shown in the table at left. The table presents the average annual
return for the past ten years for PRIMECAP, the average growth fund, and the
index, and shows
2
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the ending value of hypothetical $10,000 investments in each, assuming that
income dividends and capital gains distributions had been reinvested.
Our extra return of 3.7 percentage points versus the average growth fund had
an astounding long-term impact: A $10,000 investment in PRIMECAP Fund would have
grown to $62,048, or $16,859 more than the final value of a $10,000 investment
in the average growth fund. That is a difference of more than 11/2 times the
initial $10,000 investment. Even our seemingly modest edge of 0.8 percentage
point annually versus the S&P 500 Index amounted to a significant sum of $4,085
when compounded over a decade.
We salute PRIMECAP Management for its superb job of selecting the fund's
investments during the decade. Our low operating costs also played a role in our
strong performance relative to other funds. PRIMECAP Fund's expense ratio
(operating expenses as a percentage of average net assets) was 0.51% in 1998, a
full percentage point below the 1.53% expense ratio charged by the average
growth fund. This cost advantage of one percentage point annually gives the fund
a nice tailwind, and our adviser has made the most of this edge.
While we're proud of our long-term record, we offer two caveats. First, it
was achieved during a period that was among the most favorable ever for the U.S.
stock market in general and for growth stocks in particular. Our average return
of +20% per year over the past decade is roughly double the long-term return
from common stocks. Over the past four years, the S&P 500 Index gained an
average of +30.5% annually--a record second only to 1933-1936, when the market
and the nation were rising from the abyss of the Great Depression. It's hard to
imagine such a pace continuing. On the other hand, if inflation stays dormant,
large gains aren't necessary to earn strong real, or inflation-adjusted,
returns.
The second caveat is that PRIMECAP's performance, while stellar over the
long haul, has had its short-term disappointments. Our return surpassed that of
the S&P 500 Index in six of the past ten years, but trailed in four of those
years, including 1998. We encourage our fellow shareholders to maintain a
long-term focus when evaluating the fund.
IN SUMMARY
The past year demonstrated both the impressive rewards that the stock market can
provide and the sharp downturns that can sweep the market. Indeed, even greater
volatility--up and down--comes with the territory when investing in growth
stocks.
To help weather such volatility--and as a hedge against the possibility that
stocks won't be the best-performing asset class over any particular future
period--we recommend a balanced approach to investing. Select a mix of stock
funds, bond funds, and money market funds in proportions suited to your own
investment time horizon, financial situation, and tolerance for market
fluctuations. Once you've made such a plan, stick with it through the markets'
ups and downs. Vanguard PRIMECAP Fund will "stay the course" by continuing to
seek out stocks with strong long-term growth potential selling at reasonable
prices.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Senior Chairman Chairman and
Chief Executive Officer
January 14, 1999
3
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THE MARKETS IN PERSPECTIVE
YEAR ENDED DECEMBER 31, 1998
[PHOTO]
Financial markets continued to produce solid overall gains during 1998. After
overcoming a sharp, six-week setback in July and August, the S&P 500 Index
gained 28.6% for the year, marking the first time the index had produced returns
of 20% or more in four consecutive years. Bond prices rose as interest rates
generally declined over the year. Returns from overseas stock markets varied
widely, with big gains in Europe, small gains in the Pacific, and losses in most
emerging markets.
U.S. STOCK MARKETS
Large-capitalization stocks--especially those of large growth companies--were
the best performers during 1998. The 50 largest stocks within the S&P 500 Index
earned more than 40%, while the return of the other 450 stocks was less than
17%. The stock market as a whole, as measured by the Wilshire 5000 Equity Index,
earned 23.4%. Small-cap stocks, represented by the Russell 2000 Index, declined
2.5% for the year.
The huge gap between returns of large and small stocks was not the only
oddity during the year. Among large stocks there also was a large disparity in
performance between growth and value stocks. Within the S&P 500 Index, growth
stocks rose 42.2%, while value stocks were up 14.7%. The gap of 27.5 percentage
points is the largest in the 23 years that the growth and value components have
been tracked.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED DECEMBER 31, 1998
--------------------------------------
1 YEAR 3 YEARS 5 YEARS
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
STOCKS
S&P 500 Index 28.6% 28.2% 24.1%
Russell 2000 Index -2.5 11.6 11.9
MSCI EAFE Index 20.3 9.3 9.5
- ------------------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index 8.7% 7.3% 7.3%
Lehman 10 Year Municipal Bond Index 6.8 6.8 6.4
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 5.1 5.2 5.1
- ------------------------------------------------------------------------------
OTHER
Consumer Price Index 1.6% 2.2% 2.4%
- ------------------------------------------------------------------------------
</TABLE>
Stocks rose strongly during the first half of the year. But after hitting a
then-record high on July 17, the S&P 500 Index fell by 19.2% during the
following six weeks. Declines were steeper for most smaller stocks. The Russell
2000 Index fell nearly 40% from its peak in April before climbing back during
the fourth quarter.
The summer slump in stock prices reflected several factors that raised
anxiety among investors and prompted a reconsideration of risk that extended
past stocks to bonds. Among these factors were deteriorating corporate earnings;
Russia's default on its debts; sharp swings in currency exchange rates; and
lingering economic weakness in Asia.
Although these sources of uncertainty remained as the year went on, many
investors reacted not by abandoning stocks, but by selecting large, well-known
stocks they perceived as reliable vehicles for long-term growth. The strong
rebound in prices during the fourth quarter was due in large part to the calming
influence on jittery markets of the Federal Reserve Board's decision to cut
short-term interest rates by 0.75 percentage point.
4
<PAGE> 7
Technology stocks led the market's advance during 1998, rising 83%.
Investors were attracted by rapid revenue growth and a belief that consumers and
businesses will keep spending freely on computers, software, and computer
services. Speculation also played a role in the surge. Burgeoning activity on
the Internet sent many stocks, even those with no hint of profitability,
skyrocketing. The bulge in Internet stock prices prompted comparisons with such
historic asset "bubbles" as Japan's stock market in the late 1980s and the
tulip-bulb mania in Holland in the 1630s.
Health care and utilities, especially telecommunications providers, also
soared, achieving returns of more than 43%. Both sectors benefited from rising
demand for their products and a perception that they are somewhat protected from
foreign economic troubles and foreign competition. Consumer-related stocks such
as retailers also did well, reflecting strength in consumer spending. Americans
spent almost every after-tax dollar they earned during 1998. Jobs were abundant;
unemployment fell to 4.3% by year-end.
The worst-performing groups were two directly harmed by falling commodity
prices: oil drilling and services firms in the "other energy" category (-36%)
and materials & processing firms (-1%), such as paper, steel, and chemical
makers. Producer-durables companies, such as machinery and aircraft makers, eked
out a 2% return as companies saw falling sales abroad and rising competition at
home from foreign firms.
U.S. BOND MARKETS
The fall in interest rates during 1998 was steepest for U.S. Treasury
securities, which benefited from heightened aversion to risk among investors and
from a slight decrease in supply, thanks to a $70 billion Federal Budget
surplus. The low inflation rate--consumer prices were up just 1.6%--gave the
Federal Reserve the flexibility to cut short-term rates even though economic
growth was strong.
Yields on long-term Treasury issues fell by roughly 1 percentage point, and
the 30-year Treasury bond's yield was 5.09% on December 31. Lower rates mean
higher bond prices, and the Lehman Brothers Long U.S. Treasury Index earned a
total return of 13.5%, an astounding margin of nearly 12 percentage points over
the inflation rate.
Bonds lacking the unquestioned credit quality of Treasuries did not fare as
well, reflecting a repricing of risk and a "flight to quality" by investors who
began to feel they had been underestimating risk. One result was price declines
that nearly offset the interest earned on high-yield "junk" bonds. However,
high-quality corporate bonds and mortgage-backed securities generally held up
well. The Lehman Aggregate Bond Index, which encompasses Treasury, mortgage, and
high-quality corporate securities and has an intermediate-term average maturity,
earned a solid 8.7%.
Yields on long-term municipal bonds declined only slightly during the year,
and by December 31 were only a tad lower than yields on long-term Treasuries.
This was striking because the interest on municipals is exempt from federal
income tax.
INTERNATIONAL STOCK MARKETS
Europe's stock markets beat even the S&P 500 Index's gaudy return, gaining 28.7%
in U.S.-dollar terms, with about 5% of the gain due to a fall in the dollar
versus most European currencies. Pacific-region stocks rose 2.6%, although it
took a fall in the dollar's value versus the Japanese yen to overcome losses in
local-currency terms. Overall, developed international markets, as measured by
the MSCI EAFE Index, earned 20.3%.
Investors' confidence in emerging markets continued to evaporate in 1998,
and stocks in these markets fell about 25% as a group. The few bright spots
included South Korea (+141%) and the Philippines (+13%), which had suffered big
declines in 1997.
5
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REPORT FROM THE ADVISER
[PHOTO]
During 1998, Vanguard PRIMECAP Fund's total return of 25.4% trailed the 28.6%
return recorded by the unmanaged S&P 500 Index, but exceeded the 22.9% return
achieved by the average growth mutual fund.
Throughout the first three quarters of the year, apprehension mounted over
the turmoil in Southeast Asia, deterioration in the economies of Latin America,
and the near-collapse of the Russian economy. Investors sought safety in the
very largest-capitalization stocks, perceiving that these companies could manage
to consistently increase earnings despite the difficult global environment.
Consequently, PRIMECAP Fund--holding less than 13% of assets in very large
stocks versus 55% for the S&P 500 Index--underperformed the index in each of the
first three quarters. Through September 30, the fund was down 2.6% versus a 6.0%
gain for the S&P 500.
During the fourth quarter, signs of improving conditions in Asia,
complemented by continued strength in the domestic economy, regenerated
confidence among investors. A major rally ensued--one that was not limited to
the largest-capitalization issues. PRIMECAP Fund appreciated 28.8% in the fourth
quarter, well ahead of the 21.3% gain for the S&P 500 Index.
We view the fourth quarter as somewhat of a seminal period, and hope that it
marks a turning point in market leadership. In the fund's semiannual report, we
discussed extensively how performance had been concentrated in the very largest
stocks. However, as investors' confidence grew in the fourth quarter, they
ventured outside the universe of large stocks. It was the first quarter in a
long time that saw smaller stocks nearly keeping pace with the market averages.
During the final three months of the year, the average small-cap stock fund
appreciated 19.4% versus 21.3% for the S&P 500 Index. However, for the full year
the average stock woefully underperformed the S&P 500. In fact, although the S&P
500 Index gained 28.6% for the year, declining issues outnumbered those that
advanced in price on the New York Stock Exchange. On the Nasdaq, stocks whose
prices declined outnumbered those that registered gains by a margin of nearly
two to one.
Looking at the year in its entirety, PRIMECAP Fund's performance was
hampered by two factors: our substantial commitment to airline stocks and our
cash position. The performance of the airline stocks has been particularly
frustrating for us because operationally the companies have performed superbly.
Industry profitability hit historic highs during 1998. The outlook for traffic
and fuel costs (a major cost of doing business) remains favorable, and the
industry has exercised restraint in adding capacity. Despite the positive
current results and outlook, the stocks performed miserably in 1998. As a group,
our transportation holdings appreciated a mere 5.2% for the year. This includes
a 46.1% gain in FDX (parent company of Federal Express). We believe Federal
Express, the premier provider of overnight package
6
<PAGE> 9
delivery, will enjoy accelerating growth as the preferred fulfillment option for
burgeoning Internet commerce. We also expect the market to award to FDX a higher
price/earnings multiple, reflecting the company's accelerating growth rate and
its association with the Internet.
We concluded our 1997 report on a cautious note, explaining that we had
increased the fund's cash position to an unusually high 13% of assets. Although
we have reduced the cash position throughout the year (to 6.2% of assets as of
December 31), the cash holdings certainly hurt the fund's results.
On a more encouraging note, our substantial holdings in technology stocks
appreciated 57.5% for the year (44.4% in the fourth quarter alone). In our
semiannual report, we argued that the then-current earnings disappointments
among technology companies were primarily a function of an inventory liquidation
phenomenon. The sensational success of Dell Computer's "build to order" business
model forced others in the industry to embrace a similar strategy. This
triggered a chain reaction of inventory reduction that affected all suppliers,
but was particularly severe for semiconductor manufacturers. We also discussed
why we believed that the inventory liquidation had nearly run its course. In
retrospect, our analysis seems to have proved correct. PRIMECAP Fund enjoyed
explosive gains in our four largest semiconductor holdings during the second
half of the year: Texas Instruments, Micron Technology, Intel, and Xilinx posted
gains of 47.2%, 103.8%, 60.1%, and 91.5%, respectively.
Our holdings of communications technology stocks also added meaningfully to
the fund's results. This group was paced by Nokia's 250% gain (third best of all
NYSE stocks), while Ericsson and Tellabs also outpaced the S&P 500 Index's
return.
A third sector that made an excellent contribution to the fund's return
relative to the index was health care. Following a 69% gain in 1997, our
selections appreciated 52.7% in 1998. Medical device maker Guidant, the 1997
standout (it rose 119% that year), again led the group, rising 76.8%. Pharmacia
& Upjohn, an out-of-favor turnaround situation, posted a 58.6% gain. Medtronic,
another medical device maker, increased 42.1%.
We continue to see attractive opportunities in the broader market. The
valuation excesses that exist are primarily in the largest stocks. The fund
maintains only a small exposure to this group of stocks. We hope the fourth
quarter will indeed prove to have been a turning point, and that investors'
"flight to safety" has moderated. If so, we believe that PRIMECAP Fund is
positioned to achieve favorable relative returns.
Howard B. Schow, Portfolio Manager
Theo A. Kolokotrones, Portfolio Manager
Joel P. Fried, Assistant Portfolio Manager
F. Jack Liebau Jr., Assistant Portfolio Manager
PRIMECAP Management Company
January 11, 1999
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
FUND PROFILE
PRIMECAP FUND
This Profile provides a snapshot of the fund's characteristics as of December
31, 1998, 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 96 500
Median Market Cap $13.2B $60.3B
Price/Earnings Ratio 22.0x 28.0x
Price/Book Ratio 3.7x 4.9x
Yield 0.5% 1.3%
Return on Equity 19.3% 22.5%
Earnings Growth Rate 18.2% 17.2%
Foreign Holdings 6.5% 1.6%
Turnover Rate 13% --
Expense Ratio 0.51% --
Cash Reserves 6.2% --
</TABLE>
INVESTMENT FOCUS
- ----------------------------------------
[GRAPH]
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- ----------------------------------------
PRIMECAP S&P 500
- ----------------------------------------
<S> <C> <C>
R-Squared 0.82 1.00
Beta 1.04 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- ----------------------------------------------
<S> <C>
Texas Instruments, Inc. 5.3%
Guidant Corp. 5.1
FDX Corp. 5.0
Micron Technology, Inc. 4.6
Intel Corp. 4.3
Pharmacia & Upjohn, Inc. 3.9
Delta Air Lines, Inc. 3.2
AMR Corp. 3.0
Motorola, Inc. 2.3
Compaq Computer Corp. 2.3
- ----------------------------------------------
Top Ten 39.0%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCKS)
- --------------------------------------------------------------------------------
DECEMBER 31, 1997 DECEMBER 31, 1998
-----------------------------------------------
PRIMECAP PRIMECAP S&P 500
-----------------------------------------------
<S> <C> <C> <C>
Auto & Transportation 19.1% 15.8% 2.5%
Consumer Discretionary 9.6 8.1 12.0
Consumer Staples 1.7 1.9 9.8
Financial Services 6.5 3.1 16.2
Health Care 12.3 14.3 12.5
Integrated Oils 0.0 0.0 5.2
Other Energy 2.1 1.1 0.9
Materials & Processing 7.9 5.1 3.7
Producer Durables 10.3 11.0 3.2
Technology 29.2 33.8 16.6
Utilities 0.4 0.0 11.7
Other 0.9 5.8 5.7
- --------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 11
BETA. A measure of the magnitude of a fund'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 fund 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 fund'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 fund.
EXPENSE RATIO. The percentage of a fund'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 fund's equity assets represented by stocks
or American Depositary Receipts of companies based outside the United States.
INVESTMENT FOCUS. This grid indicates the focus of a fund in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund 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 fund, 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 fund, 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 fund's past returns can be explained by
the returns from the overall market (or its benchmark index). If a fund's total
return were precisely synchronized with the overall market's return, its
R-squared would be 1.00. If a fund'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 fund, the weighted average return on
equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a fund'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 fund has invested in
its ten largest holdings. (The average for stock mutual funds is about 30%.) As
this percentage rises, a fund'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. Funds
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 fund's income from interest and dividends. The yield,
expressed as a percentage of the fund'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, 1998
- --------------------------------------------------------------
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
1998 24.5 0.9 25.4 28.6
</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, 1988-December 31, 1998
- -------------------------------------------------------------
PRIMECAP Average S&P
Fund Growth Fund 500 Index
<S> <C> <C> <C> <C>
1988 12 10000 10000 10000
1989 03 10622 10687 10709
1989 06 11261 11529 11654
1989 09 12291 12706 12902
1989 12 12161 12544 13169
1990 03 12258 12239 12772
1990 06 13198 13108 13576
1990 09 10351 11011 11710
1990 12 11822 11857 12760
1991 03 14562 13902 14613
1991 06 14116 13772 14580
1991 09 14649 14833 15359
1991 12 15740 16136 16647
1992 03 15607 15907 16227
1992 06 15156 15427 16535
1992 09 15311 15938 17057
1992 12 17155 17393 17916
1993 03 18036 17795 18698
1993 06 18504 17906 18789
1993 09 19483 18800 19275
1993 12 20248 19234 19721
1994 03 20178 18469 18973
1994 06 20343 18080 19053
1994 09 22075 19067 19985
1994 12 22558 18821 19982
1995 03 24807 20096 21927
1995 06 28262 22103 24020
1995 09 30675 24000 25929
1995 12 30563 24618 27490
1996 03 31601 25786 28966
1996 06 33193 27010 30266
1996 09 33743 27814 31202
1996 12 36159 29354 33802
1997 03 37874 28815 34708
1997 06 43781 33481 40768
1997 09 52419 37137 43821
1997 12 49462 36781 45080
1998 03 54641 41177 51368
1998 06 55371 41979 53064
1998 09 48158 36602 47786
1998 12 62048 45189 57963
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1998
------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
PRIMECAP Fund 25.44% 25.10% 20.03% $62,048
Average Growth Fund 22.86 18.63 16.28 45,189
S&P 500 Index 28.58 24.06 19.21 57,963
- ------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------------------
10 YEARS
INCEPTION ---------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
PRIMECAP Fund 11/1/1984 25.44% 25.10% 19.11% 0.92% 20.03%
- --------------------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
FINANCIAL STATEMENTS
DECEMBER 31, 1998
[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, 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 (93.8%)
- ----------------------------------------------------------------------
AUTO & TRANSPORTATION (14.8%)
- - AMR Corp. 5,675,000 $ 336,953
(1)Airborne Freight Corp. 3,400,000 122,612
Arvin Industries, Inc. 740,000 30,849
Delta Air Lines, Inc. 7,000,000 364,000
- - FDX Corp. 6,240,000 555,360
Fleetwood Enterprises, Inc. 1,680,600 58,401
Southwest Airlines Co. 8,662,500 194,365
------------
1,662,540
------------
CONSUMER DISCRETIONARY (7.6%)
Block Drug Co. Class A 278,100 12,063
- - Costco Cos., Inc. 3,500,000 252,656
Dillard's Inc. 1,241,500 35,227
- - Filene's Basement Corp. 995,000 2,363
- - GC Cos. 200,000 8,325
The Gap, Inc. 172,500 9,703
(1)Harcourt General, Inc. 3,005,900 159,876
Lowe's Cos., Inc. 438,000 22,420
Manpower Inc. 2,720,000 68,510
(1)The McClatchy Co. Class A 1,000,000 35,375
- -(1)Neiman Marcus Group Inc. 3,230,000 80,548
NIKE, Inc. Class B 176,000 7,139
Nordstrom, Inc. 465,000 16,130
- -(1)Plantronics, Inc. 1,608,000 138,288
------------
848,623
------------
CONSUMER STAPLES (1.8%)
Brown-Forman Corp. Class B 800,000 60,550
The Seagram Co. Ltd. 3,600,000 136,800
------------
197,350
------------
ENERGY (1.1%)
Noble Affiliates, Inc. 2,100,000 51,712
(1)Pogo Producing Co. 2,600,000 33,800
Union Pacific Resources
Group, Inc. 3,900,000 35,344
------------
120,856
------------
FINANCIAL SERVICES (2.9%)
American International
Group, Inc. 1,255,386 121,302
City National Corp. 621,485 25,869
St. Paul Cos., Inc. 1,000,000 34,750
State Street Corp. 400,000 27,825
Torchmark Corp. 2,100,000 74,156
Transatlantic Holdings, Inc. 562,500 42,504
------------
326,406
------------
HEALTH CARE (13.5%)
- - Boston Scientific Corp. 2,000,000 53,625
Guidant Corp. 5,210,632 574,472
Johnson & Johnson 1,100,000 92,262
Eli Lilly & Co. 946,640 84,133
Medtronic, Inc. 1,996,888 148,269
Novartis AG ADR 1,200,000 120,300
Pharmacia & Upjohn, Inc. 7,676,900 434,704
------------
1,507,765
------------
MATERIALS & PROCESSING (4.7%)
Belden, Inc. 783,000 16,590
Engelhard Corp. 5,200,000 101,400
(1)Granite Construction Co. 2,100,000 70,481
(1)MacDermid, Inc. 1,701,000 66,552
OM Group, Inc. 1,140,000 41,610
</TABLE>
11
<PAGE> 14
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
MARKET
VALUE*
PRIMECAP FUND SHARES (000)
- ----------------------------------------------------------------------
<S> <C> <C>
Pioneer Hi-Bred
International, Inc. 1,350,000 $ 36,450
Potash Corp. of
Saskatchewan, Inc. 1,800,000 114,975
Stepan Co. 240,300 6,398
Temple-Inland Inc. 1,300,000 77,106
------------
531,562
------------
PRODUCER DURABLES (10.3%)
Caterpillar, Inc. 1,810,000 83,260
Deere & Co. 1,450,000 48,031
- - Dionex Corp. 1,020,000 37,358
Donaldson Co., Inc. 1,080,000 22,410
Flowserve Corp. 732,552 12,133
Kennametal, Inc. 1,260,000 26,775
- - Lexmark International
Group, Inc. Class A 700,000 70,350
(1)Millipore Corp. 2,820,000 80,194
Molex, Inc. 195,312 7,446
Molex, Inc. Class A 195,312 6,226
Nokia Corp. A ADR 860,000 103,576
Northern Telecom Ltd. 5,087,300 255,001
Pall Corp. 750,000 18,984
Perkin-Elmer Corp. 1,300,000 126,831
Pitney Bowes, Inc. 2,400,000 158,550
(1)Tektronix, Inc. 3,400,000 102,213
------------
1,159,338
------------
TECHNOLOGY (31.7%)
COMMUNICATIONS TECHNOLOGY (5.4%)
LM Ericsson Telephone Co.
ADR Class B 9,200,000 220,225
LM Ericsson Telephone Co.
4.25% Cvt. Pfd. 620 3,953
Motorola, Inc. 4,280,000 261,348
- - Tellabs, Inc. 1,800,000 123,413
COMPUTER SERVICES, SOFTWARE & SYSTEM (3.1%)
(1)Adobe Systems, Inc. 5,190,000 242,633
- -(1)The SABRE Group
Holdings, Inc. 2,309,200 102,759
- - Tripos Inc. 95,000 724
COMPUTER TECHNOLOGY (4.5%)
Compaq Computer Corp. 6,228,925 261,226
- -(1)Evans & Sutherland
Computer Corp. 840,000 14,805
Hewlett-Packard Co. 3,380,000 230,896
ELECTRONICS (1.9%)
Sony Corp. ADR 2,869,000 205,851
ELECTRONICS--SEMICONDUCTORS/COMPONENTS (15.5%)
Intel Corp. 4,075,000 483,142
- - LSI Logic Corp. 1,488,700 24,005
- - Micron Technology, Inc. 10,300,000 520,794
Texas Instruments, Inc. 6,990,000 598,082
- - Xilinx, Inc. 1,700,000 110,713
ELECTRONICS--TECHNOLOGY (1.3%)
- -(1)Coherent, Inc. 1,800,000 22,388
Symbol Technologies, Inc. 2,000,000 127,875
------------
3,554,832
------------
OTHER (5.4%)
- - Berkshire Hathaway, Inc.
Class B 26,250 61,688
Miscellaneous (4.8%) 542,807
------------
604,495
------------
- ----------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $6,039,731) 10,513,767
- ----------------------------------------------------------------------
<CAPTION>
FACE
AMOUNT
(000)
- ----------------------------------------------------------------------
<S> <C> <C>
TEMPORARY CASH INVESTMENT (6.5%)
- ----------------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
4.76%, 1/4/1999
(Cost $728,658) $728,658 728,658
- ----------------------------------------------------------------------
TOTAL INVESTMENTS (100.3%)
(COST $6,768,389) 11,242,425
- ----------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.3%)
- ----------------------------------------------------------------------
Other Assets--Note C 66,534
Liabilities (99,073)
------------
(32,539)
- ----------------------------------------------------------------------
NET ASSETS (100%)
- ----------------------------------------------------------------------
Applicable to 235,209,944 outstanding
$.001 par value shares of beneficial
interest (unlimited authorization) $11,209,886
======================================================================
NET ASSET VALUE PER SHARE $47.66
======================================================================
</TABLE>
* See Note A in Notes to Financial Statements.
- - Non-Income-Producing Security.
(1)Considered an affiliated company as the fund owns
more than 5% of the outstanding voting securities of
such company. The total market value of investments
in affiliated companies was $1,273,000,000.
ADR--American Depositary Receipt.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
AT DECEMBER 31, 1998, NET ASSETS CONSISTED OF:
- ----------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ----------------------------------------------------------------------
<S> <C> <C>
Paid in Capital 6,589,740 $28.02
Overdistributed Net
Investment Income (3,059) (.01)
Accumulated Net
Realized Gains 149,169 .63
Unrealized Appreciation--
Note F 4,474,036 19.02
- ----------------------------------------------------------------------
NET ASSETS $11,209,886 $47.66
======================================================================
</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, 1998
(000)
- ---------------------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
<S> <C>
Dividends* $ 59,285
Interest 66,712
Security Lending 748
-----------
Total Income 126,745
-----------
EXPENSES
Investment Advisory Fees--Note B 20,669
The Vanguard Group--Note C
Management and Administrative 26,595
Marketing and Distribution 2,214
Taxes (other than income taxes) 374
Custodian Fees 23
Auditing Fees 15
Shareholders' Reports 204
Annual Meeting and Proxy Costs 48
Trustees' Fees and Expenses 20
-----------
Total Expenses 50,162
Expenses Paid Indirectly--Note D (2)
-----------
Net Expenses 50,160
- ---------------------------------------------------------------------------------------------
NET INVESTMENT INCOME 76,585
- ---------------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 433,652
- ---------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 1,697,719
- ---------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 2,207,956
=============================================================================================
</TABLE>
*Dividend income from affiliated companies was $7,545,000.
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,
----------------------------------
1998 1997
(000) (000)
- --------------------------------------------------------------------------------------------------
INCREASE IN NET ASSETS
OPERATIONS
<S> <C> <C>
Net Investment Income $ 76,585 $ 42,005
Realized Net Gain 433,652 289,401
Change in Unrealized Appreciation (Depreciation) 1,697,719 1,327,647
---------------------------------
Net Increase in Net Assets Resulting from Operations 2,207,956 1,659,053
---------------------------------
DISTRIBUTIONS
Net Investment Income (80,088) (39,529)
Realized Capital Gain (348,822) (248,608)
---------------------------------
Total Distributions (428,910) (288,137)
---------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 3,038,897 3,307,320
Issued in Lieu of Cash Distributions 418,210 282,274
Redeemed (2,212,430) (978,333)
---------------------------------
Net Increase from Capital Share Transactions 1,244,677 2,611,261
- --------------------------------------------------------------------------------------------------
Total Increase 3,023,723 3,982,177
- --------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 8,186,163 4,203,986
---------------------------------
End of Year $ 11,209,886 $ 8,186,163
==================================================================================================
(1)Shares Issued (Redeemed)
Issued 71,476 85,932
Issued in Lieu of Cash Distributions 9,174 7,480
Redeemed (52,348) (26,285)
---------------------------------
Net Increase in Shares Outstanding 28,302 67,127
==================================================================================================
</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.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
PRIMECAP FUND
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $ 39.56 $ 30.08 $ 26.23 $ 19.98 $ 18.42
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .34 .21 .19 .22 .12
Net Realized and Unrealized Gain (Loss) on Investments 9.63 10.77 4.59 6.84 1.97
-----------------------------------------------------------------------
Total from Investment Operations 9.97 10.98 4.78 7.06 2.09
-----------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.35) (.20) (.20) (.22) (.12)
Distributions from Realized Capital Gains (1.52) (1.30) (.73) (.59) (.41)
-----------------------------------------------------------------------
Total Distributions (1.87) (1.50) (.93) (.81) (.53)
- ------------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $ 47.66 $ 39.56 $ 30.08 $ 26.23 $ 19.98
====================================================================================================================================
TOTAL RETURN 25.44% 36.79% 18.31% 35.48% 11.41%
====================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $ 11,210 $ 8,186 $ 4,204 $ 3,237 $ 1,554
Ratio of Total Expenses to Average Net Assets 0.51% 0.51% 0.59% 0.58% 0.64%
Ratio of Net Investment Income to Average Net Assets 0.78% 0.69% 0.69% 0.99% 0.79%
Portfolio Turnover Rate 13% 13% 10% 7% 8%
====================================================================================================================================
</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: Equity securities 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. Prices are taken from the primary market in which each security
trades. Temporary cash investments are valued at cost, which approximates market
value. Securities for which market quotations are not readily available are
valued by methods deemed by the Board of Trustees to represent fair 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, 1998, the advisory fee represented an effective annual rate
of 0.21% 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 Trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At December 31, 1998, the fund had contributed capital of $1,862,000
to Vanguard (included in Other Assets), representing 0.02% of the fund's net
assets and 2.6% of Vanguard's capitalization. The fund's Trustees and officers
are also Directors and officers of Vanguard.
D. The fund's custodian bank has agreed to reduce its fees when the fund
maintains cash on deposit in the non-interest-bearing custody account. For the
year ended December 31, 1998, custodian fee offset arrangements reduced expenses
by $2,000.
E. During the year ended December 31, 1998, the fund purchased $2,405,298,000 of
investment securities and sold $1,146,875,000 of investment securities, other
than temporary cash investments.
F. At December 31, 1998, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $4,474,036,000,
consisting of unrealized gains of $4,842,597,000 on securities that had risen in
value since their purchase and $368,561,000 in unrealized losses on securities
that had fallen in value since their purchase.
16
<PAGE> 19
REPORT OF INDEPENDENT
ACCOUNTANTS
[PHOTO]
To the Shareholders and Trustees 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, 1998, 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, 1998 by correspondence with the
custodian, provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
February 2, 1999
17
<PAGE> 20
SPECIAL 1998 TAX INFORMATION (UNAUDITED) FOR VANGUARD PRIMECAP FUND
This information for the fiscal year ended December 31, 1998, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $260,706,000 as capital gain dividends (from net
long-term capital gains) to shareholders during the fiscal year ended December
1998, all of which is designated as a 20% rate gain distribution.
For corporate shareholders, 29.1% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
18
<PAGE> 21
TRUSTEES AND OFFICERS
JOHN C. BOGLE
Founder, Senior Chairman of the Board, and Director/Trustee of The Vanguard
Group, Inc., and each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN
Chairman of the Board, Chief Executive Officer, and Director/Trustee of The
Vanguard Group, Inc., and each of the investment companies in The Vanguard
Group.
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.
JOANN HEFFERNAN HEISEN
Vice President, Chief Information Officer, and a member of the Executive
Committee of Johnson & Johnson; Director of Johnson & Johnson-Merck Consumer
Pharmaceuticals Co., Women First HealthCare, Inc., Recording for the Blind and
Dyslexic, The Medical Center at Princeton, and Women's Research and Education
Institute.
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, Banco Bilbao Gestinova, 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.,
NACCO Industries, and Newfield Exploration Co.
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.
THOMAS J. HIGGINS
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(R)," "S&P(R)," "S&P 500(R)," "STANDARD & POOR'S 500," 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
MILESTONES
[GRAPHIC]
The Vanguard Group is
named for HMS Vanguard,
Admiral Horatio Nelson's flagship
at the Battle of the Nile on
August 1, 1798. Our founder,
John C. Bogle, chose the name
after reading Nelson's inspiring
tribute to his fleet: "Nothing could
withstand the squadron . . .
with the judgment of the captains,
together with their valour, and that
of the officers and men of every
description, it was absolutely irresistible."
[GRAPHIC]
Walter L. Morgan, founder of
Wellington Fund, the nation's
oldest balanced mutual fund
and forerunner of today's family
of some 100 Vanguard funds,
celebrated his 100th birthday on
July 23, 1998. Mr. Morgan,
a true investment pioneer, died
six weeks later on September 2.
[GRAPHIC]
Wellington Fund,
The Vanguard Group's oldest fund,
was incorporated by Mr. Morgan
70 years ago, on December 28, 1928.
The fund was named after
the Duke of Wellington,
whose forces defeated
Napoleon Bonaparte at the
Battle of Waterloo in 1815.
[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.
Q590-02/12/1999
(C) 1999 Vanguard Marketing Corporation, Distributor. All rights reserved.
