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[PHOTO]
VANGUARD
PREFERRED STOCK
FUND
Semiannual Report
April 30, 1997
[THE VANGUARD GROUP LOGO]
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THE VANGUARD GROUP: LINKING TRADITION AND INNOVATION
At Vanguard, we treasure our rich nautical heritage--even as we steer our
course toward the twenty-first century. Our Report cover reflects that blending
of tradition and innovation, of past, present, and future.
The montage includes a bronze medallion with a likeness of our namesake, HMS
Vanguard (Lord Nelson's flagship at The Battle of the Nile); a clock built
circa 1816 in Scotland, featuring a portrait of Nelson; and several views of
our recently completed campus, which is steeped in nautical imagery--from our
buildings named after Nelson's warships (Victory, Majestic, and Goliath are
three shown), to our artwork and ornamental compass rose.
CONTENTS
A Message To
Our Shareholders
1
The Markets
In Perspective
3
Report From
The Adviser
5
Performance
Summary
7
Financial
Statements
8
Trustees And
Officers
INSIDE BACK COVER
All comparative mutual fund data are from Lipper Analytical Services, Inc. or
Morningstar unless otherwise noted.
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[PHOTO]
FELLOW SHAREHOLDER,
During the first half of Vanguard Preferred Stock Fund's 1997 fiscal year, the
U.S. economy exhibited continued strength while inflation remained tame and
interest rates nudged higher. In this environment, your Fund provided a total
return of +4.3% for the six months ended April 30, beating the returns of its
primary competitive benchmarks.
The following table compares the Fund's six-month total return
(capital change plus reinvested dividends) with those of the unmanaged Merrill
Lynch Perpetual Preferred Index (a broad measure of the preferred-stock market)
and the average fixed-income mutual fund.
<TABLE>
<CAPTION>
- -----------------------------------------------------
TOTAL RETURN
SIX MONTHS ENDED
APRIL 30, 1997
- -----------------------------------------------------
<S> <C>
Vanguard Preferred Stock Fund +4.3%
- -----------------------------------------------------
Average Fixed Income Fund +2.0%
- -----------------------------------------------------
Merrill Lynch Perpetual
Preferred Index +3.9%
- -----------------------------------------------------
</TABLE>
Our Fund's return is based on an increase in net asset value from
$9.67 per share on October 31, 1996, to $9.74 per share on April 30, 1997, with
the latter figure adjusted for the reinvestment of dividends totaling $0.34 per
share from net investment income. We expect 100% of our fiscal 1997 income
dividends to qualify for the 70% intercorporate dividends-received deduction
(DRD). The Fund's yield as of April 30, 1997, was 6.2%.
THE PERIOD IN REVIEW
A nearly ideal climate for common stocks--strong economic growth, rising
corporate profits, and relatively low inflation--prevailed during the six
months. The Standard & Poor's 500 Composite Stock Price Index, propelled by
gains in many of its marquee names (Microsoft, Coca-Cola, IBM), produced a
stellar return of +14.7% for the half-year.
In the fixed-income market, jitters about inflation sent interest
rates higher. The Federal Reserve Board raised its target for short-term
interest rates by a quarter-point to 5.50% on March 25. However, interest rates
on balance were up only slightly during the six months (by amounts ranging from
0.08% on 90-day U.S. Treasury bills to roughly 0.30% for 10-year and 30-year
Treasuries). The yield on the benchmark long-term U.S. Treasury bond moved
steadily higher during most of the period, topping out at 7.17% in mid-April.
However, the long-bond yield settled back under 7% during April's final days.
On balance, the increase in long-term interest rates from 6.64% to 6.96% during
the period engendered a roughly -4% decline in bond prices.
As you know, interest-rate fluctuations are the prime movers of the
fixed-income market, including preferred stocks, whose long-term maturities
make them highly sensitive to rate changes. But the preferred market has been
wrestling with additional influences lately, most notably the U.S. Treasury
Department's still-circulating proposal to lower the DRD from 70% to 50%. The
possibility of approval has already had a negative impact on the prices of
DRD-eligible preferred stocks. (We note that individual investors are unable to
use this tax deduction and are, therefore, not compensated for this particular
risk associated with the Fund.)
1
<PAGE> 4
Overall, the negative effects of the potential DRD reduction and of
higher interest rates were offset during the six months by a lessened supply of
new DRD-eligible preferred-stock issues, which helped support prices. The
adviser's report on page 5 provides further detail on the preferred-stock
market.
With its return of +4.3% during the six-month period, our Fund gave a
good account of itself versus the average fixed-income fund, which returned
+2.0%, and versus the Merrill Lynch Perpetual Preferred Index, at +3.9%.
Outperforming the Index, even by a marginal amount, was notable given that our
Fund incurs operating expenses and transaction costs while the Index does not.
As we have reminded you in the past, the average fixed-income fund is
a far-from-perfect standard of comparison for our Fund, which is one of the few
"pure" preferred stock mutual funds. We note that part of our return advantage
over the average fixed-income fund is due to the lower credit quality of
preferred stocks, which are junior in status to bonds with regard to claims on
both interest and principal. In addition, because preferred stocks have no
stated maturity date, they tend to have longer effective maturities than even
long-term bonds. The consequent high sensitivity to interest-rate fluctuations
works to our relative advantage during periods of steady or falling interest
rates, while it is a detriment when rates are rising.
IN SUMMARY
The sizable, sudden fluctuations in the stock market during the first half of
our fiscal year reinforced the two key messages that we have repeatedly
provided in our Reports to you. The first message, of course, concerns the
importance of holding a balanced portfolio of stock funds, bond funds, and
money market funds in proportions appropriate to your financial situation,
tolerance for risk, and investment objectives. By making it easier to ride out
episodes of market volatility, a balanced portfolio in turn helps investors to
adhere to our second message: Always "stay the course" toward your long-term
investment goals.
We look forward to reporting to you on the full 1997 fiscal year six
months hence.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Chairman of the Board President
May 19, 1997
2
<PAGE> 5
[PHOTO]
THE MARKETS IN PERSPECTIVE
SIX MONTHS ENDED APRIL 30, 1997
U.S. EQUITY MARKETS
The U.S. stock market continued to perform solidly over the six months,
reflecting a confidence based on moderate economic growth, quiescent inflation,
and solid increases in corporate profits. While concern grew among some
investors that continued economic expansion could lead to higher inflation, as
of the period's end there was no confirmed sign that inflation had increased.
The inflation fears nonetheless led to an erratic upward drift in interest
rates amid the ongoing strong returns from domestic equities.
Those strong returns have, however, been concentrated in the shares of
large companies. The Standard & Poor's 500 Composite Stock Price Index, for
example, gained 14.7% over the six-month period, compared to a meager 1.6% gain
for the Russell 2000 Index. In April alone, the S&P 500 Index beat the Russell
2000 Index by 5.7% (6.0% versus 0.3%). Larger companies have outperformed their
smaller-capitalization counterparts fairly consistently since the end of 1993.
There are a variety of theories as to why, including better earnings growth,
greater productivity, and fewer negative earnings surprises.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
TOTAL RETURNS
PERIODS ENDED APRIL 30, 1997
-----------------------------------------------
6 MONTHS 1 YEAR 5 YEARS*
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 14.7% 25.1% 17.1%
Russell 2000 Index 1.6 0.1 13.7
MSCI-EAFE Index 1.7 -0.6 10.9
- ----------------------------------------------------------------------------------------------
FIXED-INCOME
Lehman Aggregate Bond Index 1.7% 7.1% 7.4%
Lehman 10-Year Municipal
Bond Index 2.3 6.4 7.5
Salomon 90-Day U.S. Treasury Bills 2.6 5.2 4.5
- ----------------------------------------------------------------------------------------------
OTHER
Consumer Price Index 1.2% 2.5% 2.8%
- ----------------------------------------------------------------------------------------------
</TABLE>
*Average annual.
The recent gap in performance between large and small is particularly
noticeable in two sectors: technology and health care. Over the past six
months, technology issues in the S&P 500 Index have gained 26.3% while those in
the Russell 2000 Index have dropped -11.9%. In health care, the S&P's holdings
gained 17.6%, compared to a decline of -6.8% in the Russell 2000 Index. Within
these sectors, the larger companies' dominant products and the predictable
earnings they generate appear to be the primary difference.
Financial-services firms, by contrast, have generally fared well
regardless of size, with gains of 16.9% in the S&P 500 Index and 12.2% in the
Russell 2000 Index since October. The strength of the economy, which helps to
keep bad-debt levels at a minimum, and the overall growth of consumer credit
have helped these stocks greatly.
U.S. FIXED-INCOME MARKETS
The erratic rise in interest rates during the past six months reflected rising
and falling expectations regarding economic growth and inflation. During
November, investors seemed to expect a slowing of growth, and the 10-year U.S.
Treasury's yield declined from 6.38%
3
<PAGE> 6
to 6.04%. The same note's yield then rose to 6.67% in late January, riding a
perception that growth was markedly stronger than analysts had expected. Then
the pattern repeated itself, with the 10-year's rate falling to 6.26% in
mid-February and rising to 6.90% at the end of March. In April, the consensus
seemed to be shifting again, with the 10-year Treasury yield falling to 6.72%.
There is a simple explanation for this interest rate seesaw. Many
investors consider it a paradox that the economy has continued to expand at a
robust pace accompanied by strong job growth and low unemployment--but no
increase in inflation. Bond investors have therefore been particularly
sensitive to economic reports that might reveal inflation to be creeping up at
last. The data have been variable, tilting the consensus back and forth between
expectations of higher or continued stable inflation rates. The most recent
releases depict an exceptionally strong economy. For example, the U.S. economy
expanded at a 5.6% rate in the first quarter with no inflationary pressures
(e.g., declining producer prices and an increase of only 2.5% in employment
costs).
The net result for bond investors has been mediocre returns. The 1.7%
generated by the Lehman Brothers Aggregate Bond Index over the past six months,
for example, consists of an income return of 3.4% and a capital decline of
- -1.7%, reflecting the modest increase in interest rates. During this period,
investors who favored shorter-maturity and lower-quality issues achieved
somewhat better returns. Mortgage-backed securities performed well on a
relative basis, as higher rates led to fewer mortgage refinancings. Municipal
issues also tended to perform better than their taxable counterparts.
INTERNATIONAL EQUITY MARKETS
With the dollar strengthening by 10% to 16% against most major currencies, U.S.
investors who held foreign equities faced a headwind during the past six
months. (The major exception was the pound sterling, which was effectively
unchanged against the dollar.) The Morgan Stanley Capital International-Europe,
Australasia, Far East Index gained 1.7% in dollar terms, while in local terms
the return was 11.2%. Those who favored Europe over the Pacific region did not
feel the pain as much, due to the strong (23.1%) return generated by the local
markets. For U.S. investors, European markets provided 11.9%. The strength of
the European markets can be attributed to several factors, including (1)
ongoing efforts to lower government deficits consistent with the Maastricht
Treaty guidelines, (2) improving economic growth, and (3) a greater commitment
by corporate executives to increasing "shareholder value."
Investors with a focus in the Pacific markets were less fortunate, as
illustrated by the weak Japanese market, which fell -3.2% (a -13.2% drop for
dollar-based investors). Despite positive news, including reports of growth in
exports, lower inventories, and higher industrial production, the focus in the
Japanese market has been the poor quality of many banks' balance sheets and the
likely effects of an increase in the consumption tax. However, according to
some observers, the level of economic activity seems to be improving now in
Japan.
4
<PAGE> 7
[PHOTO]
REPORT FROM THE ADVISER
For the six months ended April 30, 1997, Vanguard Preferred Stock Fund
posted a total return of 4.3%, exceeding the returns of both of our principal
benchmarks: the average fixed-income mutual fund (2.0%) and the Merrill Lynch
Perpetual Preferred Stock Index (3.9%). Our return for the 12 months ended
April 30 was 12.0%, which also surpassed the returns achieved by the average
competing mutual fund (6.8%) and the Index (8.7%).
AN OVERVIEW OF THE PERIOD
Long-term interest rates rose by slightly more than 30 basis points (0.30
percentage point) from the beginning to the end of our fiscal half-year. The
Federal Reserve Board raised short-term interest rates by 25 basis points on
March 25. Because of these increases, the prices of debt securities generally
have declined.
Surprisingly, preferred-stock prices have remained relatively firm in
this mildly negative environment for fixed-income securities. The underlying
strength in the market for preferred stock also held up despite uncertainty
stemming from the U.S. Treasury Department's proposal to lower the
intercorporate dividends-received deduction (DRD) from 70% to 50% on
preferred-stock dividends. This suggested change in tax legislation could
potentially slice 7% to 8% off the price of a typical DRD-eligible, perpetual
preferred. Such a drop in price would be necessary to restore the yield on
preferred stocks to the same after-tax level it now has.
The potential negative effects from the proposed reduction in the DRD
and the increase in interest rates have been offset by a continued lack of
newly issued DRD-eligible preferred stocks, which has created a shortage of
available merchandise.
MARKET UPDATE
A major event in the last six months in the high-grade corporate bond market
has been the issuance and acceptance of "trust preferreds." These preferreds,
which are not eligible for the DRD and thus not appropriate for your Fund, are
viewed by banking regulators as core capital for banks and by credit-rating
agencies as something akin to equity for nonfinancial issuers. Therefore, these
securities have become popular among certain issuers. Trust preferreds are
typically purchased by the standard corporate bond buyer, not by the
preferred-stock investor. The President's budget proposal would limit the
deduction of a trust preferred's dividend in an attempt to curb these
"equity-flavored" debt instruments.
Among issues that are DRD-eligible and are being purchased by the
Fund, "DRD protection" remains important because the proposal to lower the DRD
rate is still under consideration. The prospectus of an issue with DRD
protection states that the issuer will increase the
INVESTMENT PHILOSOPHY
This Fund is managed in the interest of corporations able to use the 70%
"intercorporate dividends-received" deduction under federal tax law. The
adviser believes that the Fund can provide a relatively high and sustainable
level of income that qualifies for the deduction by investing primarily in
dividend-paying, high-quality, cumulative preferred stocks. (Note: Individual
investors are unable to use this tax deduction and are, therefore, not
compensated for the interest-rate and credit risks inherent in the Fund.)
5
<PAGE> 8
dividend if the DRD is lowered so that on an after-tax basis the investor is
left whole with respect to income.
Six months ago, we mentioned that banks were issuing several new
preferreds with an unusual structure. Known as "fixed-rate adjustable
preferreds," these securities have DRD protection and pay dividends at a fixed
rate for five years. After five years, dividends fluctuate as market interest
rates change. These preferreds are noncumulative, which allows banks that issue
the securities to count them as "Tier One," or base, capital. However, because
trust preferreds have certain features that are more favorable for issuers, we
do not expect any significant issuance of the fixed-rate adjustable preferreds
in the future.
INVESTMENT GOALS AND STRATEGY
The investment goals and strategy of the Fund are consistent with those that
were put in place when it was started in 1975. Relatively high-quality
preferred stocks are purchased with the goal of qualifying all of the Fund's
dividends for the 70% DRD. We achieved total qualification in fiscal 1996, as
we have in all previous years, and we expect to do the same in fiscal 1997.
Another objective of the Fund is to provide sustainable, tax-advantaged income
through holdings of investment-grade preferreds.
The risk to the Fund's net asset value from a reduction in the DRD is
always present and cannot be predicted. That risk can be mitigated only
marginally through investment in DRD-protected securities. The risk to the Fund
from rising long-term interest rates is also a constant. However, we can
attempt to control income risk and variability by investing in the securities
of high-quality companies with call protection. Stability of income should
also be strengthened by broad diversification. The Fund currently owns
preferred stocks of some 50 issuers.
The Fund's credit-quality breakdown is as follows: cash and
Treasuries, 4% of assets; AA, 18%; A, 41%; BBB, 37%. A total of 44% of Vanguard
Preferred Stock Fund's assets are concentrated in securities issued by 27
companies in the electric utility industry. We continue to believe that the
risks and rewards from investing in this industry are favorably balanced. To
provide industry diversification, we also seek to own securities issued by
high-quality financial-services companies.
Earl E. McEvoy, Senior Vice President
Wellington Management Company, LLP
May 13, 1997
6
<PAGE> 9
PERFORMANCE SUMMARY
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Fund. Note, too, that
both share price and return can fluctuate widely so that an investment in the
Fund could lose money.
<TABLE>
<CAPTION>
PREFERRED STOCK FUND
TOTAL INVESTMENT RETURNS: OCTOBER 31, 1976-APRIL 30, 1997
- ---------------------------------------------------------
PREFERRED STOCK FUND MERRILL LYNCH
FISCAL CAPITAL INCOME TOTAL INDEX*
YEAR RETURN RETURN RETURN TOTAL RETURN
- ---------------------------------------------------------
<S> <C> <C> <C> <C>
1977 2.5% 8.7% 11.2% 10.5%
1978 -6.7 8.3 1.6 -2.2
1979 -12.2 8.1 -4.1 -4.9
1980 -9.1 10.3 1.2 -3.4
1981 -10.9 11.4 0.5 -3.7
1982 17.5 18.6 36.1 27.0
1983 1.5 11.9 13.4 16.6
1984 -6.9 12.5 5.6 5.3
1985 9.7 14.2 23.9 23.4
1986 20.7 11.9 32.6 37.9
1987 -17.8 7.2 -10.6 -3.8
1988 0.5 11.9 12.4 8.7
1989 8.6 7.2 15.8 14.5
1990 -4.6 8.9 4.3 -3.1
1991 10.2 10.6 20.8 28.8
1992 2.9 8.4 11.3 13.5
1993 7.2 8.4 15.6 10.4
1994 -15.2 6.7 -8.5 -5.0
1995 15.1 8.7 23.8 18.0
1996 0.6 7.4 8.0 7.4
1997** 0.7 3.6 4.3 3.9
- ---------------------------------------------------------
</TABLE>
*S&P Preferred Index through March 1989; Merrill Lynch Perpetual Preferred
Index thereafter.
**Six months ended April 30, 1997.
See Financial Highlights table on page 12 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED MARCH 31, 1997*
- ------------------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION --------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Preferred Stock Fund 12/3/75 10.72% 9.24% 0.18% 8.43% 8.61%
- ------------------------------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
7
<PAGE> 10
[PHOTO]
FINANCIAL STATEMENTS
APRIL 30, 1997 (unaudited)
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 (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*
PREFERRED STOCK FUND SHARES (000)
- ---------------------------------------------------------------------------
PREFERRED STOCKS (95.9%)
- ---------------------------------------------------------------------------
<S> <C> <C>
AUTO & TRANSPORTATION (4.4%)
Ford Motor Co. 8.25% 425,000 $ 11,687
General Motors Corp. 7.92% 66,300 1,732
----------
13,419
----------
CONSUMER STAPLES (2.3%)
McDonald's Corp. 7.72% 265,500 6,837
----------
FINANCIAL SERVICES (45.2%)
BANKS-NEW YORK CITY (10.0%)
Bankers Trust New York Corp.
7.50% 150,000 3,806
Chase Manhattan Corp. 7.50% 150,000 3,844
Citicorp 8.30% 275,000 7,322
J. P. Morgan & Co., Inc. 6.625% 250,000 12,875
Republic New York Corp. 7.25% 86,000 2,247
BANKS-OUTSIDE NEW YORK CITY
(14.7%)
ABN-AMRO North America 6.075% 5,000 4,999
- - ABN-AMRO North America 6.59% 4,000 3,920
BankBoston Corp. 7.875% 280,000 7,280
Comerica Inc. 6.84% 150,000 7,688
Fleet Financial Group 6.75% 145,000 7,540
Fleet Financial Group 7.25% 50,000 1,306
NationsBank Corp. 8.75% 9,000 234
PNC Bank Corp. 6.05% 125,000 6,205
Wells Fargo & Co. 6.59% 100,000 5,121
FINANCE COMPANIES (5.6%)
Beneficial Corp. $4.30 80,050 5,203
Beneficial Corp. 5.00% 40,000 1,450
Household International, Inc.
7.35% 400,000 10,250
FINANCIAL-MISCELLANEOUS (9.7%)
Federal Home Loan
Mortgage Corp. 6.125% 250,000 12,625
Federal National
Mortgage Assn. 6.41% 35,800 1,817
Federal National
Mortgage Assn. 6.45% 165,800 8,456
MBNA Corp. 7.50% 250,000 6,500
INSURANCE-LIFE (1.0%)
W. R. Berkley Corp. 7.375% 117,725 3,002
SECURITIES BROKERS & SERVICES
(4.2%)
Morgan Stanley Group 5.91% 40,000 1,960
Morgan Stanley Group 7.75% 200,000 10,700
----------
136,350
----------
TECHNOLOGY (0.1%)
International Business
Machines Corp. 7.50% 16,000 426
----------
UTILITIES-ELECTRICAL (43.9%)
Alabama Power Co. 6.40% 200,000 4,875
Arizona Public Service 7.25% 208,916 5,275
Baltimore Gas & Electric Co. 6.70% 39,700 4,093
Baltimore Gas & Electric Co. 6.99% 35,000 3,777
Baltimore Gas & Electric Co. 7.125% 40,000 4,186
Commonwealth Edison Co. $7.24 50,000 4,675
Duke Power Co. 6.375% 97,900 2,374
Duke Power Co. 7.00% 50,000 5,105
</TABLE>
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<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ---------------------------------------------------------------------------
<S> <C> <C>
Duke Power Co. 7.85% 25,000 $ 2,673
Entergy Arkansas Inc. $1.96 60,000 1,476
Entergy Louisiana Inc. 4.16% 7,000 395
Entergy Louisiana Inc. 4.44% 6,000 356
Florida Power & Light Co. 6.75% 10,000 1,047
Florida Power & Light Co. 6.98% 75,000 7,950
Gulf Power Co. 5.44% 5,500 428
Idaho Power Co. 7.07% 25,000 2,539
Illinois Power Co. 4.20% 6,850 206
Illinois Power Co. 4.26% 14,000 420
Illinois Power Co. 4.42% 15,600 484
Illinois Power Co. 7.75% 25,000 1,292
Monongahela Power Co. 7.73% 50,000 5,350
Oklahoma Gas & Electric Co.
5.34% 5,950 473
PECO Energy Co. 7.48% 50,000 5,194
PSI Energy Inc. 6.875% 40,000 4,160
PSI Energy Inc. 7.44% 200,000 5,125
Pacific Gas & Electric Co. 4.36% 11,800 184
Pacific Gas & Electric Co. 5.00% 39,800 726
Pacific Gas & Electric Co. 7.04% 150,000 3,937
Pennsylvania Power & Light Co.
6.75% 85,000 9,279
Puget Sound Energy 7.45% 240,000 6,420
San Diego Gas & Electric Co.
6.80% 140,000 3,612
Savannah Electric & Power Co.
6.64% 140,000 3,465
Sierra Pacific Power Co. 7.80% 200,000 5,535
- - South Carolina Electric & Gas Co.
6.52% 65,000 6,598
Southern California Edison Co. 4.24% 14,200 220
Southern California Edison Co.
5.80% 10,800 235
Texas Utilities Electric Co. $4.76 3,786 258
Texas Utilities Electric Co. 7.50% 52,000 1,371
Texas Utilities Electric Co. $7.98 45,000 5,265
Union Electric Co. $7.64 33,000 3,484
Virginia Electric & Power Co.
$6.98 60,000 6,442
West Penn Power Co. 4.20% 5,000 307
Wisconsin Public Service Co.
6.88% 10,000 1,024
----------
132,290
----------
- ---------------------------------------------------------------------------
TOTAL PREFERRED STOCKS
(COST $281,838) 289,322
- ---------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- ---------------------------------------------------------------------------
<S> <C> <C>
U.S. GOVERNMENT OBLIGATION (1.7%)
- ---------------------------------------------------------------------------
U.S. TREASURY BOND
6.50%, 11/15/26
(COST $5,069) $5,250 $ 4,931
- ---------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (2.3%)
- ---------------------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.31%, 5/1/97
(COST $6,936) 6,936 6,936
- ---------------------------------------------------------------------------
TOTAL INVESTMENTS (99.9%)
(COST $293,843) 301,189
- ---------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (0.1%)
- ---------------------------------------------------------------------------
Other Assets--Note C 2,319
Liabilities (1,882)
----------
437
- ---------------------------------------------------------------------------
NET ASSETS (100%)
- ---------------------------------------------------------------------------
Applicable to 30,974,036 outstanding
shares of beneficial interest
(unlimited authorization--no par value) $301,626
===========================================================================
NET ASSET VALUE PER SHARE $9.74
===========================================================================
</TABLE>
*See Note A in Notes to Financial Statements.
- -Non-Income Producing Security. New issue that has not paid a dividend as of
April 30, 1997.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
AT APRIL 30, 1997, NET ASSETS CONSISTED OF:
- ---------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ---------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital--Note A $295,747 $9.55
Undistributed Net
Investment Income--Note A 1,622 .05
Accumulated Net Realized Losses (3,089) (.10)
Unrealized Appreciation--Note E 7,346 .24
- ---------------------------------------------------------------------------
NET ASSETS $301,626 $9.74
===========================================================================
</TABLE>
9
<PAGE> 12
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>
- -----------------------------------------------------------------------------------------
PREFERRED STOCK FUND
SIX MONTHS ENDED APRIL 30, 1997
(000)
- -----------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $10,151
Interest 163
---------
Total Income 10,314
---------
EXPENSES
Investment Advisory Fee--Note B 199
The Vanguard Group--Note C
Management and Administrative 324
Marketing and Distribution 35
Custodian Fees 1
Auditing Fees 4
Shareholders' Reports 2
Annual Meeting and Proxy Costs 1
---------
Total Expenses 566
- -----------------------------------------------------------------------------------------
NET INVESTMENT INCOME 9,748
- -----------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 1,236
- -----------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 1,212
- -----------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $12,196
=========================================================================================
</TABLE>
10
<PAGE> 13
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the Fund's total net assets changed during the two
most recent reporting periods. The Operations section summarizes information
that is detailed in the Statement of Operations. The amounts shown as
Distributions to shareholders from the Fund's net income and capital gains may
not match the amounts shown in the Operations section, because distributions
are determined on a tax basis and may be made in a period different from the
one in which the income was earned or the gains were realized on the financial
statements. The Capital Share Transactions section shows the amount
shareholders invested in the Fund, either by purchasing shares or by
reinvesting distributions, as well as the amounts redeemed. The corresponding
numbers of Shares Issued and Redeemed are shown at the end of the Statement.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
PREFERRED STOCK FUND
---------------------------------
SIX MONTHS YEAR
ENDED ENDED
APR. 30, 1997 OCT. 31, 1996
(000) (000)
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income 9,748 21,355
Realized Net Gain 1,236 1,305
Change in Unrealized Appreciation (Depreciation) 1,212 (552)
---------------------------
Net Increase in Net Assets Resulting from Operations 12,196 22,108
---------------------------
DISTRIBUTIONS
Net Investment Income (10,325) (20,847)
Realized Capital Gain -- --
---------------------------
Total Distributions (10,325) (20,847)
---------------------------
NET EQUALIZATION CHARGES--NOTE A -- (370)
---------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 48,736 56,872
Issued in Lieu of Cash Distributions 7,514 15,200
Redeemed (42,194) (95,268)
---------------------------
Net Increase (Decrease) from Capital Share Transactions 14,056 (23,196)
- -----------------------------------------------------------------------------------------------------------
Total Increase (Decrease) 15,927 (22,305)
- -----------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 285,699 308,004
---------------------------
End of Period $301,626 $285,699
===========================================================================================================
(1)Shares Issued (Redeemed)
Issued 5,047 6,073
Issued in Lieu of Cash Distributions 778 1,634
Redeemed (4,384) (10,239)
---------------------------
Net Increase (Decrease) in Shares Outstanding 1,441 (2,532)
===========================================================================================================
</TABLE>
11
<PAGE> 14
FINANCIAL HIGHLIGHTS
This table summarizes the Fund's investment results and distributions to
shareholders on a per-share basis. It also presents the Fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the Fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the Fund's total return; how much it costs to operate the
Fund; and the extent to which the Fund tends to distribute capital gains.
The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in
the Fund for one year. Finally, the table lists the Fund's Average Commission
Rate Paid, a disclosure required by the SEC beginning in 1996. This rate is
calculated by dividing total commissions paid on portfolio securities by the
total number of shares purchased and sold on which commissions were charged.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
PREFERRED STOCK FUND
YEAR ENDED OCTOBER 31,
FOR A SHARE OUTSTANDING SIX MONTHS ENDED ----------------------------------------------------------------
THROUGHOUT EACH PERIOD APRIL 30, 1997 1996 1995 1994 1993 1992
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $9.67 $9.61 $8.35 $9.99 $9.32 $9.06
- ----------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .32 .69 .66 .66 .690 .749
Net Realized and Unrealized Gain (Loss)
on Investments .09 .04 1.25 (1.46) .685 .236
--------------------------------------------------------------------------
Total from Investment Operations .41 .73 1.91 (.80) 1.375 .985
--------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.34) (.67) (.65) (.70) (.705) (.725)
Distributions from Realized Capital Gains -- -- -- (.14) -- --
--------------------------------------------------------------------------
Total Distributions (.34) (.67) (.65) (.84) (.705) (.725)
- ----------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $9.74 $9.67 $9.61 $8.35 $9.99 $9.32
============================================================================================================================
TOTAL RETURN 4.30% 8.04% 23.79% -8.45% 15.56% 11.34%
============================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $302 $286 $308 $305 $392 $187
Ratio of Total Expenses to
Average Net Assets 0.38%* 0.39% 0.52% 0.51% 0.53% 0.58%
Ratio of Net Investment Income to
Average Net Assets 6.58%* 7.23% 7.43% 7.27% 6.77% 7.43%
Portfolio Turnover Rate 35%* 31% 20% 27% 45% 33%
Average Commission Rate Paid $.0600 $.0600 N/A N/A N/A N/A
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
*Annualized.
12
<PAGE> 15
NOTES TO FINANCIAL STATEMENTS
Vanguard Preferred Stock 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 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. EQUALIZATION: Prior to November 1996, the Fund followed the
accounting practice known as "equalization," under which a portion of the price
of capital shares issued and redeemed, equivalent to undistributed net
investment income per share on the date of the transaction, was credited or
charged to undistributed net investment income. As a result, undistributed
income per share was unaffected by capital share transactions. As of November
1, 1996, the Fund has discontinued equalization accounting and has reclassified
accumulated net equalization credits of $1,837,000 from undistributed net
investment income to paid in capital. This reclassification has no effect on
the Fund's net assets, results of operations, or net asset value per share.
4. 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.
5. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
6. 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. Wellington Management Company, LLP provides investment advisory
services to the Fund for a fee calculated at an annual percentage rate of
average net assets. For the six months ended April 30, 1997, the advisory fee
represented an effective annual rate of 0.13% 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. At April 30, 1997, the Fund had contributed capital of $25,000 to
Vanguard (included in Other Assets), representing 0.1% of Vanguard's
capitalization. The Fund's trustees and officers are also directors and
officers of Vanguard.
D. During the six months ended April 30, 1997, the Fund purchased
$56,397,000 of investment securities and sold $48,021,000 of investment
securities, other than U.S. government securities and temporary cash
investments. Purchases and sales of U.S. government securities were $6,329,000
and $3,412,000, respectively.
At October 31, 1996, the Fund had available a capital loss
carryforward of $4,273,000 to offset future net capital gains of $345,000
through October 31, 2002, and $3,928,000 through October 31, 2003.
13
<PAGE> 16
E. At April 30, 1997, net unrealized appreciation of investment
securities for financial reporting and federal income tax purposes was
$7,346,000, consisting of unrealized gains of $8,910,000 on securities that had
risen in value since their purchase and $1,564,000 in unrealized losses on
securities that had fallen in value since their purchase.
14
<PAGE> 17
TRUSTEES 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 Business Solutions, Inc., Raytheon Co., Knight-Ridder, Inc., and
Massa-chusetts Mutual Life Insurance Co.; 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
Communications Co.
ALFRED M. RANKIN, JR., Chairman, President, and Chief Executive Officer of
NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich
Co., and The Standard Products Co.
JOHN C. SAWHILL, President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co.
and President of New York University; Director of Pacific Gas and
Electric Co., Procter & Gamble Co., and NACCO Industries.
JAMES O. WELCH, JR., Retired Chairman of Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc.
and Kmart Corp.
J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas Co.;
Director of Cummins Engine Co.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY, Secretary; Senior Vice President and Secretary of The
Vanguard Group, Inc.; Secretary of each of the investment companies in
The Vanguard Group.
RICHARD F. HYLAND, Treasurer; Principal of The Vanguard Group, Inc.; Treasurer
of each of the investment companies in The Vanguard Group.
KAREN E. WEST, Controller; Principal of The Vanguard Group, Inc.; Controller of
each of the investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
ROBERT A. DISTEFANO, Senior Vice President,
Information Technology.
JAMES H. GATELY, Senior Vice President,
Individual Investor Group.
IAN A. MACKINNON, Senior Vice President,
Fixed Income Group.
F. WILLIAM MCNABB III, Senior Vice President, Institutional.
RALPH K. PACKARD, Senior Vice President and
Chief Financial Officer.
[THE VANGUARD GROUP LOGO]
Please send your comments to us at:
Post Office Box 2600, Valley Forge, Pennsylvania 19482
Fund Information: 1-800-662-7447
Individual Account Services: 1-800-662-2739
Institutional Investor Services: 1-800-523-1036
http://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 investing or sending money. Prospectuses
may be obtained directly from The Vanguard Group.
(C) 1997 Vanguard Marketing Corporation, Distributor
<PAGE> 18
[PHOTO]
THE VANGUARD FAMILY OF FUNDS
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(CA, NJ, OH, PA)
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(CA, FL, NJ, NY, OH, PA)
Q382-4/97
