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VANGUARD(R)
PREFERRED STOCK
FUND
ANNUAL REPORT
October 31, 1999
[PHOTO OF SHIP]
[A MEMBER OF THE VANGUARD GROUP LOGO]
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[PHOTO OF JOHN C. BOGLE]
JOHN C. BOGLE
FELLOW SHAREHOLDERS:
TWO ROADS DIVERGED IN A WOOD, AND I--I TOOK THE ONE LESS TRAVELED BY, AND
THAT HAS MADE ALL THE DIFFERENCE.
I can think of no better words than those of Robert Frost to begin this special
letter to our shareholders, who have placed such extraordinary trust in me and
in Vanguard over the past quarter century. When the firm was founded 25 years
ago, we deliberately took a new road to managing a mutual fund enterprise.
Instead of having the funds controlled by an outside management company with its
own financial interests, the Vanguard funds--there were only 11 of them
then--would be controlled by their own shareholders and operate solely in their
financial interests. The outcome of our unprecedented decision was by no means
certain. We described it then as "The Vanguard Experiment."
Well, I guess it's fair to say it's an experiment no more. During the past
25 years, the assets we hold in stewardship for investors have grown from $1
billion to more than $500 billion, and I believe that our reputation for
integrity, fair-dealing, and sound investment principles is second to none in
this industry. Our staggering growth--which I never sought--has come in
important part as a result of the simple investment ideas and basic human values
that are the foundation of my personal philosophy. I have every confidence that
they will long endure at Vanguard, for they are the right ideas and right
values, unshakable and eternal.
While Emerson believed that "an institution is the lengthened shadow of one
man," Vanguard today is far greater than any individual. The Vanguard crew has
splendidly implemented and enthusiastically supported our founding ideas and
values, and deserves the credit for a vital role in forging our success over the
years. It is a dedicated crew of fine human beings, working together in an
organization that is well prepared to press on regardless long after I am gone.
Creating and leading this enterprise has been an exhilarating run. Through it
all, I've taken the kudos and the blows alike, enjoying every moment to the
fullest, and even getting a second chance at life with a heart transplant three
years ago. What more could a man ask?
While I shall no longer be serving on the Vanguard Board, I want to assure
you that I will remain vigorous and active in a newly created Vanguard unit,
researching the financial markets, writing, and speaking. I'll continue to focus
whatever intellectual power and ethical strength I possess on my mission to
assure that mutual fund investors everywhere receive a fair shake. In the spirit
of Robert Frost:
BUT I HAVE PROMISES TO KEEP, AND MILES TO GO BEFORE I SLEEP, AND MILES
TO GO BEFORE I SLEEP.
You have given me your loyalty and friendship over these long years, and I
deeply appreciate your thousands of letters of support. For my part, I will
continue to keep an eagle eye on your interests, for you deserve no less. May
God bless you all, always.
/S/
JCB
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CONTENTS
Report From The Chairman ...........1 Performance Summary ..................9
Notice To Shareholders .............4 Fund Profile ........................10
The Markets In Perspective .........5 Financial Statements ................12
Report From The Adviser ............7 Report Of Independent Accountants....19
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[PHOTO OF JOHN J. BRENNAN]
JOHN J. BRENNAN
REPORT FROM THE CHAIRMAN
Bond prices tumbled in the face of higher interest rates during Vanguard
Preferred Stock Fund's 1999 fiscal year, resulting in paltry returns for
fixed-income investments during the 12 months ended October 31. In this
difficult environment, your fund's total return of -2.5% fell short of the slim
gains recorded by its comparative benchmarks.
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TOTAL RETURNS
FISCAL YEAR ENDED
OCTOBER 31, 1999
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Vanguard Preferred Stock Fund -2.5%
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Average Fixed-Income Fund* 1.4%
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Merrill Lynch DRD-Eligible
Preferred Index 1.2%
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*Derived from data provided by Lipper Inc.
The adjacent table compares the fund's 12-month total return (capital
change plus reinvested dividends) with those of the average fixed-income mutual
fund and the Merrill Lynch DRD-Eligible Preferred Stock Index, a broad measure
of the preferred stock market.
Our return is based on a decline in net asset value from $10.36 per share
on October 31, 1998, to $9.44 per share on October 31, 1999, and is adjusted for
the reinvestment of dividends totaling $0.56 per share paid from net investment
income and a distribution of $0.125 per share paid from net realized capital
gains. Once again, 100% of our income dividends qualified for the 70%
intercorporate dividends-received deduction (DRD), a tax advantage that is
available to corporations but not to individual investors. The fund's yield on
October 31 was 6.1%.
Since its 1975 inception, Vanguard Preferred Stock Fund has achieved the
goal of qualifying all of its income for the dividends-received deduction.
However, over the past several years, the number of preferred stocks that are
eligible for this corporate tax break has dwindled. Consequently, as explained
in the notice on page 4, the fund's Board of Trustees has decided to allow the
Preferred Stock Fund to invest in securities that do not qualify for the
dividends-received deduction--a move that will broaden the range of securities
available as investments to the fund's adviser. The Report From The Adviser
beginning on page 7 provides details about the environment for preferred stocks.
THE FINANCIAL MARKETS IN REVIEW
The fiscal year comprised two distinctly different halves. For most of the first
half, stock prices worldwide were rebounding strongly from a slump in the summer
of 1998 that had been prompted by economic crises in Asia, Russia, and parts of
Latin America. The acceleration in global economic activity, the continued
ebullience of the U.S. economy, and a series of interest rate reductions by the
Federal Reserve Board that fall helped erase investors' fears that the troubles
abroad would depress business activity and profits at home.
However, it wasn't long before this giddy mood, which drove stock prices
higher and kept bond yields near 5%, evaporated. During the first few months of
1999, fears of a global economic slump were supplanted by worries that economic
growth--especially in the United States--was so strong that it would cause wages
and commodity prices to surge, pushing up inflation. A strong uptrend in
interest rates ensued. The Federal Reserve encouraged this move, twice boosting
short-term interest rates by a total of 0.50
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percentage point. The increase in rates dampened the enthusiasm for stocks and
inflicted significant damage on bond prices, which move in the opposite
direction from yields.
For the full year, the yield of the 30-year Treasury bond increased exactly
1 percentage point (100 basis points), from 5.16% at the end of fiscal 1998 to
6.16% on October 31, 1999. The yield on the 10-year Treasury note rose 141 basis
points, from 4.61% to 6.02%. The rise in short-term interest rates was less
dramatic--yields of 3-month Treasury bills were 77 basis points higher on
balance, rising from 4.32% when the fiscal year began to 5.09% when it ended.
Bond returns suffered. The Lehman Brothers Aggregate Bond Index, a benchmark for
taxable bonds, eked out a return of just 0.5% for the year, as its interest
income of 6.2% only barely offset price declines of -5.7%. Returns from
long-term corporate bonds were in negative territory for the fiscal year. The
Lehman Long Corporate AA or Better Bond Index returned -2.4%, reflecting an
- -8.9% price decline and a 6.5% income return.
FISCAL 1999 PERFORMANCE OVERVIEW
Vanguard Preferred Stock Fund's fiscal 1999 return of -2.5% was below the
slightly positive returns of both the average fixed-income fund (1.4% for the 12
months) and the Merrill Lynch DRD-Eligible Preferred Index (1.2%). It's
important to note the distinct differences between your fund and its comparative
benchmarks. First, preferred stocks have no stated maturities, and therefore are
more sensitive to changes in interest rates than even long-term bonds.
Consequently, with rates rising, our holdings fared worse, on average, than
those of the average fixed-income mutual fund, which invests in a wide range of
bonds with varying maturities. Also, the credit quality of preferred stocks is
generally lower than for bonds, which have a higher claim on interest and
principal in corporations' capital structures.
The fund's fiscal 1999 return was its lowest since the 1994 fiscal year,
when it fell -8.5% during one of the worst years on record for the fixed-income
market. But interest rates can also fall and provide a boost for bonds, as they
did for much of the past decade. Indeed, the fund returned 23.8% during fiscal
1995, just one year after registering its dismal performance in fiscal 1994. The
lesson is that interest rate fluctuations are an ever-present, if unpredictable,
part of fixed-income investing.
LONG-TERM PERFORMANCE OVERVIEW
A mutual fund's record should not be measured over months or a year, but rather
over many years. The table at the top of the next page presents the average
annual returns over the past decade for your fund, the average fixed-income
mutual fund, and the Merrill Lynch DRD-Eligible Preferred Index. It also
presents the results of hypothetical $10,000 investments made a decade ago in
the fund and its comparative standards. Our goal is to exceed the returns of
similar mutual funds over the long term--an objective that we are proud to say
we have accomplished. The Preferred Stock Fund's solid annualized return of 8.9%
over the past ten years is excellent relative to similar mutual funds. An
initial $10,000 investment in your fund would have grown to $23,507 over the
decade, compared with the $19,734 in the average fixed-income fund. On balance,
interest rates declined over the past decade, which aided your fund more than
the average fixed-income fund.
The credit for our success goes to our investment adviser, Wellington
Management Company, which has managed the fund since its inception 24 years ago,
as well as to our low costs. Our expense ratio (annual expenses as a percentage
of average net assets) of 0.36% is just a fraction of the 1.05% charged by the
average fixed-income fund. Because
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these expenses are deducted directly from the income earned by a mutual fund,
our cost advantage gives the Preferred Stock Fund a head start toward its goal
of providing superior returns.
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TOTAL RETURNS
10 YEARS ENDED OCTOBER 31, 1999
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AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
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Vanguard Preferred Stock Fund 8.9% $23,507
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Average Fixed-Income Fund 7.0% $19,734
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Merrill Lynch DRD-Eligible
Preferred Index* 8.2% $22,038
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*Merrill Lynch Perpetual Preferred Index through January 1997;
Merrill Lynch DRD-Eligible Preferred Index thereafter.
Of course, our past returns can't help us divine the fund's future
performance. However, a reliable indicator of long-term fixed-income
returns--albeit an imperfect one--is the current yield on bonds. This estimate,
which assumes that changes in interest rates are offsetting over long periods,
suggests that future returns from fixed-income securities may not be as generous
as they were over the past decade.
IN SUMMARY
The returns of bonds and stocks diverged sharply during the 12 months ended
October 31. Though this divergence was unsettling to some bond investors, it
should not be considered unusual. The fact is, an individual security, an
industry, or an entire asset class may struggle while others shine.
Because of such divergences and the unpredictable nature of the financial
markets, we firmly believe in diversifying investment programs to gain exposure
to the different asset classes, as well as to a variety of issues within each
class. Such a balanced approach is the surest road to long-term investing
success. Creating such a program tailored to your objectives, time horizon for
investing, and tolerance for risk--and sticking with it through good times and
bad--allows you to participate in the rewards of the financial markets while
limiting the risk.
/S/
John J. Brennan
Chairman and Chief Executive Officer
November 12, 1999
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A Note of Thanks to Our Founder
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As you may have read on the inside cover of our report, our founder, John C.
Bogle, is retiring December 31, 1999, as Senior Chairman of our Board after
nearly 25 years of devoted service to Vanguard and our shareholders. Vanguard
investors have Jack to thank for creating a truly mutual mutual fund company
that operates solely in the interest of its fund shareholders. And mutual fund
investors everywhere have benefited from his energetic efforts to improve this
industry. Finally, on a personal note, I am forever grateful to Jack for giving
me the opportunity to join this great company in 1982.
3
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NOTICE TO SHAREHOLDERS
CHANGE IN INVESTMENT OBJECTIVE
The Board of Trustees of Vanguard Preferred Stock Fund has decided to change the
fund's investment objective of maximizing dividend income that qualifies for the
federal intercorporate dividends-received deduction (DRD). (As you know,
corporations may exclude from taxable income 70% of the income from DRD-
eligible securities.) The fund's new objective is to provide a high level of
current income, a significant portion of which will be DRD-eligible. Our
investment adviser, Wellington Management Company, will gradually and
opportunistically introduce non-DRD- eligible preferred stock into the fund
after March 1, 2000.
The Board's decision was made after careful consideration of changes in the
preferred stock environment. When the fund was launched in 1975, DRD-eligible
securities represented the majority of preferred stock issuance. However, over
the past few years, the number of DRD-eligible securities issued has shrunk
dramatically as companies turned to a different type of preferred stock, called
trust preferred. This type of preferred offers greater benefits to the issuer,
because the dividend payments are deductible as interest expense; however, these
dividends do not qualify for the DRD. Therefore, these securities are
inappropriate for the Preferred Stock Fund under its current investment
objective. The lack of new issues of DRD-eligible preferred stock has made it
increasingly difficult for the adviser to both maintain a diversified portfolio
and meet the fund's investment objective of maximum DRD-eligible income.
By adding non-DRD-eligible preferred stocks to its holdings, the fund will
provide a higher pretax yield, offering a direct benefit to those investors not
able to utilize the DRD. However, it is expected that the fund's after-tax yield
for shareholders eligible for the DRD will decrease marginally (roughly 0.1 to
0.2 percentage point). After weighing these factors, your Board decided that the
benefits of improved investment flexibility and diversification would more than
compensate in the long run for the slight reduction in after-tax yield for
shareholders eligible to claim the DRD.
November 26, 1999
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THE MARKETS IN PERSPECTIVE
YEAR ENDED OCTOBER 31, 1999
Caution followed exuberance in the U.S. stock market during the fiscal year
ended October 31, 1999. Improving economic conditions during the first half of
the year set off a raucous rally from the lows of summer 1998, when fears of a
global economic slump swept world markets. However, during the second half of
the fiscal year, interest rates kept rising, pulling down bond prices and
tempering the stock market's optimism. The notion of a global slump was replaced
by worries that economic growth might be so strong as to threaten a surge in
inflation.
U.S. STOCK MARKETS
A booming U.S. economy and solid increases in corporate earnings lifted the U.S.
stock market, especially during the first half of the fiscal year. The nation's
economic output increased by about 4% during the year. Consumer spending, which
accounts for roughly two-thirds of economic activity, powered the expansion.
Americans spent virtually every dollar they earned, encouraged by rising wealth
from a long bull market, plentiful employment, and rising incomes. (After-tax
personal income rose about 5% during the year; unemployment fell to a 30-year
low of 4.1% of the workforce in October.)
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AVERAGE ANNUAL RETURNS
PERIODS ENDED OCTOBER 31, 1999
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1 YEAR 3 YEARS 5 YEARS
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STOCKS
S&P 500 Index 25.7% 26.5% 26.0%
Russell 2000 Index 14.9 9.4 12.6
Wilshire 5000 Index 25.7 23.8 23.8
MSCI EAFE Index 23.4 12.5 9.5
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BONDS
Lehman Aggregate Bond Index 0.5% 6.2% 7.9%
Lehman 10 Year Municipal Bond Index -1.2 5.2 7.0
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 4.6 5.0 5.2
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OTHER
Consumer Price Index 2.6% 2.0% 2.4%
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From October 31, 1998, through April 30, 1999, the stock market rose 22.8%,
as measured by the Wilshire 5000 Total Market Index. Investor confidence,
already high due to the booming economy, was bolstered by easier monetary
policy--the Federal Reserve cut short-term interest rates in November 1998 for
the third time in less than two months. But by summer, the Fed reversed course,
twice boosting its target for short-term interest rates to slow the economy and
reduce inflationary pressures.
Higher interest rates helped take the steam out of the stock market's rally
during the second half of the fiscal year, even though estimates of corporate
earnings kept rising. Higher rates tend to hurt stocks because many investors
use current interest rates to discount the value of a stock's projected earnings
and dividends. The higher the rate, the more future earnings are discounted, and
the less investors will pay for the stock now. After a second-half gain of 2.3%,
the Wilshire 5000 Index recorded a 25.7% return for the full fiscal year.
Big stocks outperformed small stocks in fiscal 1999, and growth stocks
outpaced value stocks. The S&P 500 Index, which is dominated by
large-capitalization stocks, gained
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25.7%, while the small-cap Russell 2000 Index was up 14.9%. Growth stocks--whose
high prices in relation to earnings, book value, and dividends indicate high
expectations for future growth--lost none of their appeal, despite soaring
valuations for many. Both large- and small-cap growth issues gained roughly 30%,
while value stocks within the S&P 500 Index were up 19.0%, and the Russell
2000's value stocks had a scant 0.7% return.
The growth/value gap was due partly to the incredible performance of
technology stocks, most of which are classified as growth issues. Within the S&P
500 Index, tech stocks gained 67% during the fiscal year. Advances of about 30%
were recorded by retailers and other consumer-discretionary stocks and by the
utilities sector, where gains were concentrated in telecommunications stocks.
The only sector with a loss was consumer staples (-8%), where food and beverage
company stocks suffered from falling profits. Other laggards were the auto &
transportation sector (+6%) and health-care stocks (+9%).
U.S. BOND MARKETS
Rapid economic growth was a help to the stock market but a hindrance to bonds.
Investors worried that, with unemployment so low, growth above the 2.5% to 3%
range would cause wages and prices to accelerate. Indeed, inflation did rise a
bit, although the Consumer Price Index was up a relatively modest 2.6% during
the 12-month period.
As mentioned, the Fed sought to combat inflationary pressures by increasing
short-term interest rates by a quarter-point on June 30 and again on August 24.
The bond market was already pushing up rates well before the Fed acted. Yields
of long-term U.S. Treasury bonds began rising significantly in February. By
fiscal year-end, the 30-year Treasury bond's yield was 6.16%, up precisely 1
percentage point for the year. The 10-year Treasury's yield rose 1.41 percentage
points, from 4.61% to 6.02%. Short-term interest rates didn't rise as far, and
3-month Treasury bill yields were up 0.77 point to 5.09% at fiscal year-end.
Rising interest rates mean lower prices for existing bonds, of course.
Price declines were higher for longer-term bonds, which are most sensitive to
changing rates. For the taxable bond market as a whole, as measured by the
Lehman Aggregate Bond Index, prices fell -5.7%, resulting in a total return of
just 0.5% for the fiscal year. High-yield (junk) bonds and mortgage-backed
securities posted higher returns than Treasuries.
INTERNATIONAL STOCK MARKETS
International markets soared in local currencies during the 12 months ended
October 31, with European stocks gaining 22.7% and Pacific-region stocks
advancing 37.8%. The U.S. dollar rose in value against most European currencies
but fell against the Japanese yen. For U.S. investors, the upshot of these
currency fluctuations was to trim returns from Europe to 12.7% in dollar terms
and to boost returns from the Pacific to 50.5%.
In the major developed international markets, U.S. investors earned 23.4%,
as measured by the Morgan Stanley Capital International Europe, Australasia, Far
East (EAFE) Index. The bull markets in most nations stemmed from a renewed
appetite for risk on the part of investors encouraged by clear signs of
expanding business activity and generally easier monetary policy. Japan and the
rest of Asia, which were hit hardest by currency and economic crises in 1997 and
1998, saw the biggest gains. In Japan, massive government spending programs
appeared to be working--at least in the short run--to lift that nation out of a
recession.
Emerging markets, as measured by the Select Emerging Markets Free Index,
gained 34.1% for U.S. investors, as local returns of better than 70% were cut
nearly in half by weaker currencies in Latin America and eastern Europe.
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REPORT FROM THE ADVISER
For the 6- and 12-month periods ended October 31, 1999, Vanguard Preferred Stock
Fund posted total returns of -4.9% and -2.5%, respectively.
AN OVERVIEW OF THE PERIOD
The fiscal year began on November 1, 1998, with the yield of the long-term U.S.
Treasury bond at 5.16% and the yield of a representative preferred stock at
about 5.50%. Twelve months later, long-term yields are higher by 1 percentage
point--an increase that damaged the market for preferred stocks. However, a
continuing lack of new issuance provided some support and kept prices from
falling further. Thus, while bond prices fell across the board over the year as
interest rates rose, the declines were cushioned somewhat for preferred stocks
because demand has been in line with the limited supply.
Also helping was the absence of uncertainty about the status of the
intercorporate dividends-received deduction (DRD)--a worry that has plagued the
preferred stock market from time to time. We know of no proposals to reduce the
DRD from the existing level of 70%.
MARKET UPDATE
Tenders and calls to retire older preferred issues have ceased because many
higher-rate securities were retired earlier in the year. The economic incentive
for issuers to eliminate DRD-eligible preferred stocks is still high, however,
because dividends, unlike interest expense, cannot be deducted on the income
statement. Thus, retired preferreds typically are not replaced by similar issues
at lower dividend rates. The DRD-eligible preferred remains a relatively
expensive financing vehicle; as a result, the market for these securities has
grown quite thin.
During the summer of 1999, risk premiums widened across global capital
markets as the Federal Reserve Board twice tightened credit by hiking short-term
interest rates. The marginal borrower had to pay a relatively steeper price to
obtain credit. Preferred stock issuers were no exception. (Preferred dividends
are paid after all debt obligations, including bonds, are serviced.) By the
fiscal year-end, however, the markets were beginning to believe that the Federal
Reserve might not have to tighten much more to achieve its goal of
noninflationary economic growth. Thus, risk premiums began to recede a bit in
the domestic fixed-income markets. On October 31, the after-tax yield for
a-rated perpetual utility preferreds was 192 basis points (1.92 percentage
points) higher than that of the 30-year Treasury bond, up from a difference of
115 basis points six months ago. The ten-year average is 199 basis points.
Compared with municipal bonds, preferreds currently offer 3 basis points more
after-tax yield, far lower than the average of 66 basis points of extra
after-tax yield over the past ten years. Thus, based on historical
relationships, preferred stocks are fairly valued versus Treasuries and
expensive versus municipals.
With the U.S. Treasury running a budget surplus, the federal government's
need for new sources of revenue is less urgent. Thus, the threat of a reduction
of the DRD is lower than it has been for some time. Even
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INVESTMENT PHILOSOPHY
The adviser believes that the fund can provide a relatively high and sustainable
level of income by investing primarily in dividend-paying, high-quality,
preferred stocks.
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so, the market is demanding that new DRD-eligible preferred issues have
protection against a lowering of the corporate tax deduction. The prospectus of
a "DRD-protected issue" states that the dividend will increase if the DRD is
lowered, ensuring that the investor is left whole on an after-tax basis with
respect to income. We view this protection as necessary insurance against any
change in tax laws, which could severely hurt prices for preferred stocks.
However, the protection typically expires 18 months after the preferred is
issued.
INVESTMENT GOALS AND STRATEGY
The fund's investment goals and strategy are consistent with those that were put
in place at its 1975 inception. We purchase relatively high-quality preferreds
with the goal of providing an attractive, and sustainable, level of after-tax
income. We 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. On October 31, the fund
owned preferred stocks from 50 issuers.
The risk to the fund's net asset value from any future lowering of the DRD
can be mitigated marginally through investment in DRD-protected securities. The
risk to the fund from rising long-term interest rates is a constant and cannot
be hedged; preferreds without a stated maturity perform very poorly in an
environment of rising rates. We expect rates to rise slightly as global
economies continue to recover. However, with inflation expected to be 2% or
lower, rates should not rise substantially. The Fed's constant warnings about
the historically high economic growth rate will keep the fixed-income markets
slightly off-balance.
As of October 31, Vanguard Preferred Stock Fund's quality breakdown--based
on Moody's Investors Service ratings--was cash, 3%; aa-rated securities, 29%; a,
52%; baa, 16%. The fund's largest sector exposure--with securities equal to 47%
of assets from 25 issuers--is in the electric utility industry. High-quality
financial-service issuers account for the next-largest industry sector.
Earl E. McEvoy, Senior Vice President
Wellington Management Company, LLP
November 5, 1999
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PERFORMANCE SUMMARY
PREFERRED STOCK 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. An investor's shares, when
redeemed, could be worth more or less than their original cost.
TOTAL INVESTMENT RETURNS: OCTOBER 31, 1979-OCTOBER 31, 1999
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PREFERRED STOCK FUND MERRILL LYNCH
INDEX*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
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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 12.3
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PREFERRED STOCK FUND MERRILL LYNCH
INDEX*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- --------------------------------------------------------------------------------
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 5.2 7.2 12.4 8.8
1998 1.9 6.1 8.0 6.4
1999 -7.8 5.3 -2.5 1.2
1997 13.8 6.4 20.2 19.4
1998 6.4 5.4 11.8 13.9
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*S&P Preferred Index through March 1989;
Merrill Lynch Perpetual Preferred Index through January 1997;
Merrill Lynch DRD-Eligible Preferred Index thereafter.
See Financial Highlights table on page 16 for dividend and capital
gains information for the past five years.
CUMULATIVE PERFORMANCE: OCTOBER 31, 1989-OCTOBER 31, 1999
[MOUNTAIN CHART]
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198910 10000 10000 10000
199001 9880 9931 9390
199004 9887 9871 9183
199007 10529 10418 9868
199010 10428 10215 9689
199101 11027 10640 10461
199104 11609 11155 11325
199107 11780 11412 11547
199110 12600 12005 12476
199201 13215 12348 13037
199204 13237 12498 13215
199207 13954 13100 13814
199210 14029 13181 14165
199301 14498 13620 14364
199304 15112 14007 14893
199307 15579 14369 15249
199310 16212 14699 15639
199401 16285 14878 15915
199404 15162 14233 14848
199407 15282 14352 15079
199410 14841 14222 14858
199501 15297 14405 15342
199504 16503 14974 16235
199507 17445 15519 16911
199510 18373 15963 17526
199601 18839 16506 18023
199604 18488 16172 17900
199607 18990 16365 18188
199610 19849 16929 18822
199701 20261 17175 19171
199704 20703 17266 19517
199707 21882 18048 20048
199710 22318 18357 20472
199801 23179 18819 20968
199804 23426 18998 21096
199807 23991 19283 21616
199810 24103 19389 21787
199901 24491 19825 22173
199904 24731 19847 22445
199907 24027 19553 22288
199910 23507 19734 22038
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED OCTOBER 31, 1999
------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- --------------------------------------------------------------------------------
Preferred Stock Fund -2.47% 9.63% 8.92% $23,507
Average Fixed-Income Fund* 1.39 6.73 7.03 19,734
Merrill Lynch DRD-Eligible
Preferred Index** 1.16 8.20 8.22 22,038
- --------------------------------------------------------------------------------
* Derived from data provided by Lipper Inc.
**S&P Preferred Index through March 1989; Merrill Lynch Perpetual Preferred
Index through January 1997; Merrill
Lynch DRD-Eligible Preferred Index thereafter.
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED SEPTEMBER 30, 1999*
- --------------------------------------------------------------------------------
10 YEARS
INCEPTION -----------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------
Preferred Stock Fund 12/3/1975 -2.55% 9.73% 1.48% 7.76% 9.24%
- --------------------------------------------------------------------------------
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
9
<PAGE>
FUND PROFILE
PREFERRED STOCK FUND
This Profile provides a snapshot of the fund's characteristics as of October 31,
1999, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on page 11.
PORTFOLIO CHARACTERISTICS
- --------------------------------------------------------------------------------
PREFERRED MERRILL LYNCH
STOCK INDEX*
- --------------------------------------------------------------------------------
Number of Securities 78 28
Yield 6.1% 6.2%
Average Coupon 6.3% 7.1%
Average Quality a2 a2
Turnover Rate 11% --
Expense Ratio 0.36% --
Cash Reserves 2.8% --
*Merrill Lynch DRD-Eligible Preferred Index.
DISTRIBUTION BY CREDIT QUALITY
(% OF PORTFOLIO)
- --------------------------------------------------------------------------------
Treasury/Agency 0.0%
aaa 0.0
aa 28.5
a 52.2
baa 16.2
ba 0.0
b 0.0
Not Rated 3.1
- --------------------------------------------------------------------------------
Total 100.0%
DISTRIBUTION BY COUPON
(% OF PORTFOLIO)
- --------------------------------------------------------------------------------
Under 4% 2.0%
4%-5% 6.8
5%-6% 23.4
6%-7% 43.5
7%-8% 24.3
8%-9% 0.0
9%-10% 0.0
Over 10% 0.0
- --------------------------------------------------------------------------------
Total 100.0%
TEN LARGEST HOLDINGS
(% OF TOTAL NET ASSETS)
- --------------------------------------------------------------------------------
Federal Home Loan Mortgage Corp. 11.2%
Baltimore Gas & Electric Co. 4.7
Alabama Power Co. 4.6
Citigroup, Inc. 4.3
Florida Power & Light Co. 4.3
South Carolina Electric & Gas Co. 3.8
J.P. Morgan & Co., Inc. 3.3
Fleet Boston Corp. 3.1
Morgan Stanley Dean Witter Co. 2.9
PP&L Resources, Inc. 2.9
- --------------------------------------------------------------------------------
Top Ten 45.1%
SECTOR DIVERSIFICATION (% OF PREFERRED STOCKS)
- --------------------------------------------------------------------------------
OCTOBER 31, 1998 OCTOBER 31, 1999
------------------------------------------
PREFERRED STOCK PREFERRED STOCK
------------------------------------------
Auto & Transportation ................. 0.0% 0.0%
Consumer Discretionary ................ 0.0 0.0
Consumer Staples ...................... 3.5 1.1
Financial Services .................... 52.7 45.8
Health Care ........................... 0.0 0.0
Integrated Oils ....................... 0.0 0.0
Other Energy .......................... 0.0 1.4
Materials & Processing ................ 0.2 2.5
Producer Durables ..................... 0.0 0.0
Technology ............................ 0.4 0.5
Utilities ............................. 43.2 48.7
Other ................................. 0.0 0.0
- --------------------------------------------------------------------------------
10
<PAGE>
AVERAGE COUPON. The average interest rate paid on the securities held by a fund.
It is expressed as a percentage of face value.
AVERAGE QUALITY. An indicator of credit risk, this figure is the average of the
ratings assigned to a fund's securities holdings by credit-rating agencies. The
agencies make their judgment after appraising an issuer's ability to meet its
obligations. Quality is graded on a scale, with "aaa" indicating the most
creditworthy issuers.
CASH RESERVES. The percentage of a fund's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing
securities.
DISTRIBUTION BY COUPON. A breakdown of the securities in a fund according to
coupon rate-- the interest rate that an issuer promises to pay, expressed as an
annual percentage of face value.Securities with unusually high coupon rates may
be subject to call risk, the possibility that they will be redeemed (or
"called") early by the issuer.
DISTRIBUTION BY CREDIT QUALITY. This breakdown of a fund's securities by credit
rating can help in gauging the risk that returns could be affected by defaults
or other credit problems.
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.
NUMBER OF SECURITIES. An indicator of diversification. The more securities a
fund holds, the more diversified it is and the less susceptible to a price
decline stemming from the problems of a particular company.
SECTOR DIVERSIFICATION. The percentage of preferred stocks from issuers in 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. 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 period. 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 the rate of return an investor would receive if
the securities were held to their maturity dates.
11
<PAGE>
FINANCIAL STATEMENTS
OCTOBER 31, 1999
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.
- --------------------------------------------------------------------------------
MARKET
VALUE*
PREFERRED STOCK FUND SHARES (000)
- --------------------------------------------------------------------------------
PREFERRED STOCKS (97.2%)
- --------------------------------------------------------------------------------
CONSUMER STAPLES (1.1%)
(1)Ocean Spray Cranberries, Inc.
6.25% 25,000 2,345
Stokely-Van Camp Corp. 5.00% 56,410 941
-------------
3,286
-------------
ENERGY (1.4%)
Apache Corp. 5.68% 50,000 4,302
-------------
FINANCIAL SERVICES (44.5%)
BANKS--NEW YORK CITY (7.8%)
The Chase Manhattan Corp.
4.96% 175,000 8,444
J. P. Morgan & Co., Inc. 6.625% 200,000 10,350
Republic New York Corp. 5.715% 125,000 5,625
BANKS--OUTSIDE NEW YORK CITY (9.8%)
(1) ABN-AMRO North America 6.59% 9,000 8,882
Comerica, Inc. 6.84% 75,000 3,806
Fleet Boston Corp. 6.75% 190,000 9,785
(1) LaSalle National Bank 6.46% 2,000 2,010
PNC Bank Corp. 6.05% 50,000 2,538
Wells Fargo & Co. 6.59% 75,000 3,849
DIVERSIFIED FINANCIAL SERVICES (6.0%)
Citigroup, Inc. 6.365% 275,000 13,544
Household International
Inc. $4.30 75,000 5,175
FINANCE COMPANIES (1.2%)
Heller Financial, Inc. 6.687% 40,000 3,876
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
FINANCIAL--MISCELLANEOUS (14.4%)
Federal Home Loan Mortgage
Corp. 5.00% 400,000 15,900
Federal Home Loan Mortgage
Corp. 5.10% 100,000 4,884
Federal Home Loan Mortgage
Corp. 5.79% 200,000 9,300
Federal Home Loan Mortgage
Corp. 6.14% 100,000 5,225
Federal National Mortgage
Assn. 6.45% 100,000 5,138
MBNA Corp. 7.50% 200,000 5,050
INSURANCE--PROPERTY-CASUALTY (2.4%)
(1)Hillbrook Insurance Co. 5.90% 75 7,481
SECURITIES BROKERS & SERVICES (2.9%)
Morgan Stanley Dean Witter
Co., 7.75% 175,000 9,231
-------------------
140,093
-------------------
MATERIALS & PROCESSING (2.4%)
Alcoa, Inc. $3.75 77,490 5,037
E.I. du Pont de Nemours &
Co. 3.50% 15,600 877
E.I. du Pont de Nemours &
Co. $4.50 22,925 1,674
-------------------
7,588
-------------------
TECHNOLOGY (0.5%)
International Business Machines
Corp. 7.50% 57,500 1,513
-------------------
12
<PAGE>
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
UTILITIES (47.3%)
UTILITIES--ELECTRICAL (47.1%)
Alabama Power Co. 5.20% 690,000 14,317
Baltimore Gas & Electric
Co. 6.70% 39,700 4,252
Baltimore Gas & Electric
Co. 6.97% 10,900 1,177
Baltimore Gas & Electric
Co. 6.99% 35,000 3,815
Baltimore Gas & Electric
Co. 7.125% 52,000 5,603
Boston Edison Co. 4.78% 2,000 154
Carolina Power & Light Co. 5.44% 4,319 374
Duke Energy Corp. 6.375% 31,100 793
Duke Energy Corp. 7.00% 3,362 357
Duke Energy Corp. 7.04% 1,558 169
Duke Energy Corp. 7.85% 20,544 2,232
Duquesne Light Co. 3.75% 4,200 122
Duquesne Light Co. 4.10% 6,710 226
Duquesne Light Co. 4.15% 9,160 270
Florida Power & Light Co. 6.75% 20,000 2,134
Florida Power & Light Co. 6.98% 105,000 11,249
Idaho Power Co. 7.07% 25,000 2,653
Indianapolis Power & Light 5.65% 75,000 6,966
Monongahela Power Co. 7.73% 50,000 5,406
PECO Energy Co. $4.30 1,060 66
PECO Energy Co. $7.48 50,000 5,359
PP&L Resources, Inc. 6.75% 85,000 8,968
PSI Energy Inc. 4.16% 4,050 69
PSI Energy Inc. 4.32% 8,890 140
PSI Energy Inc. 6.875% 40,000 4,320
Pacific Gas & Electric Co. 4.36% 11,800 189
Pacific Gas & Electric Co. 4.50% 3,600 59
Pacific Gas & Electric Co. 5.00% 42,300 801
Pacific Gas & Electric Co. 7.04% 210,000 5,434
PacifiCorp $1.28 7,036 140
PacifiCorp 7.48% 75,000 7,776
Potomac Electric Power Co. $2.28 37,000 1,367
Potomac Electric Power Co. $2.46 35,000 1,395
Puget Sound Energy 7.45% 240,000 6,495
San Diego Gas & Electric
Co. $1.70 140,000 3,641
Sierra Pacific Power Co. 7.80% 200,000 5,303
South Carolina Electric & Gas
Co. 6.52% 115,000 11,902
TXU Electric Co. $1.805 8,300 214
TXU Electric Co. $1.875 112,800 2,922
TXU Electric Co. $4.76 3,786 281
TXU Electric Co. $4.84 5,500 425
TXU Electric Co. $7.98 45,000 4,826
Union Electric Co. $4.56 12,150 863
Union Electric Co. $7.64 34,000 3,720
Virginia Electric & Power
Co. $6.98 60,000 6,453
Wisconsin Power & Light
Co. 6.20% 18,500 1,862
Wisconsin Public Service
Corp. 6.88% 10,000 1,066
- --------------------------------------------------------------------------------
MARKET
VALUE*
PREFERRED STOCK FUND SHARES (000)
- --------------------------------------------------------------------------------
UTILITIES--TELECOMMUNICATIONS (0.2%)
GTE California Inc. 4.50% 822 12
GTE California Inc. 5.00% 15,339 254
GTE Florida Inc. $1.25 5,120 106
GTE Florida Inc. $1.30 6,200 133
-------------------
148,830
-------------------
- --------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS
(COST $313,968) 305,612
- --------------------------------------------------------------------------------
FACE
AMOUNT
(000)
- --------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (2.6%)
- --------------------------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.24% 11/1/1999
(Cost $8,169) $8,169 8,169
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (99.8%)
(COST $322,137) 313,781
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (0.2%)
- --------------------------------------------------------------------------------
Other Assets--Note C 2,150
Liabilities (1,379)
-------------------
771
- --------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------
Applicable to 33,320,222 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $314,552
================================================================================
NET ASSET VALUE PER SHARE $9.44
================================================================================
*See Note A in Notes to Financial Statements.
(1)Security exempt from registration under Rule 144A of
the Securities Act of 1933. These securities may be sold
in transactions exempt from registration, normally to
qualified institutional buyers. At October 31, 1999, the
aggregate value of these securities was $20,718,000,
representing 6.6% of net assets.
- --------------------------------------------------------------------------------
AT OCTOBER 31, 1999, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- --------------------------------------------------------------------------------
Paid in Capital $321,924 $9.66
Undistributed Net
Investment Income 1,177 .04
Accumulated Net Realized Loss (193) (.01)
Unrealized Depreciation--
Note F (8,356) (.25)
================================================================================
NET ASSETS $314,552 $9.44
================================================================================
13
<PAGE>
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.
- --------------------------------------------------------------------------------
PREFERRED STOCK FUND
YEAR ENDED OCTOBER 31, 1999
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Dividends $ 21,604
Interest 304
-------------
Total Income 21,908
-------------
EXPENSES
Investment Advisory Fee--Note B 455
The Vanguard Group--Note C
Management and Administrative 725
Marketing and Distribution 72
Custodian Fees 12
Auditing Fees 9
Shareholders' Reports 18
Trustees' Fees and Expenses 1
-------------
Total Expenses 1,292
Expenses Paid Indirectly--Note D (3)
-------------
Net Expenses 1,289
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 20,619
- --------------------------------------------------------------------------------
REALIZED NET LOSS ON INVESTMENT SECURITIES SOLD (110)
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
OF INVESTMENT SECURITIES (28,274)
- --------------------------------------------------------------------------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (7,765)
================================================================================
14
<PAGE>
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.
- --------------------------------------------------------------------------------
PREFERRED STOCK FUND
YEAR ENDED OCTOBER 31,
- --------------------------------------------------------------------------------
1999 1998
(000) (000)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 20,619 $ 19,843
Realized Net Gain (Loss) (110) 6,265
Change in Unrealized Appreciation (Depreciation) (28,274) 53
----------------------------
Net Increase (Decrease) in Net Assets Resulting
from Operations (7,765) 26,161
----------------------------
DISTRIBUTIONS
Net Investment Income (19,870) (20,808)
Realized Capital Gain (4,518) --
----------------------------
Total Distributions (24,388) (20,808)
----------------------------
CAPITAL SHARE TRANSACTIONS1
Issued 86,045 130,539
Issued in Lieu of Cash Distributions 18,858 15,646
Redeemed (138,952) (90,903)
----------------------------
Net Increase (Decrease) from
Capital Share Transactions (34,049) 55,282
- --------------------------------------------------------------------------------
Total Increase (Decrease) (66,202) 60,635
- --------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 380,754 320,119
============================
End of Year $314,552 $380,754
================================================================================
1Shares Issued (Redeemed)
Issued 8,516 12,503
Issued in Lieu of Cash Distributions 1,886 1,509
Redeemed (13,836) (8,731)
----------------------------
Net Increase (Decrease) in Shares Outstanding (3,434) 5,281
================================================================================
15
<PAGE>
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>
- ---------------------------------------------------------------------------------------------------
PREFERRED STOCK FUND
YEAR ENDED OCTOBER 31,
<S> <C> <C> <C> <C> <C>
---------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1999 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $10.36 $10.17 $ 9.67 $9.61 $8.35
- ---------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .590 .58 .63 .69 .66
Net Realized and Unrealized Gain (Loss)
on Investments (.825) .22 .53 .04 1.25
---------------------------------------------------
Total from Investment Operations (.235) .80 1.16 .73 1.91
---------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.560) (.61) (.66) (.67) (.65
Distributions from Realized Capital Gains (.125) -- -- -- --
---------------------------------------------------
Total Distributions (.685) (.61) (.66) (.67) (.65
- ---------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $ 9.44 $10.36 $10.17 $9.67 $9.61
===================================================================================================
TOTAL RETURN -2.47% 8.00% 12.44% 8.04% 23.79%
===================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $315 $381 $320 $286 $308
Ratio of Total Expenses to Average Net Assets 0.36% 0.36% 0.37% 0.39% 0.52%
Ratio of Net Investment Income to Average
Net Assets 5.76% 5.60% 6.41% 7.23% 7.43%
Portfolio Turnover Rate 11% 39% 34% 31% 20%
===================================================================================================
</TABLE>
16
<PAGE>
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: 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. Bonds are valued using the lastest bid prices or using valuations based
on a matrix system (which considers such factors as security prices, yields,
maturities, and ratings), both as furnished by independent pricing services.
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. Distributions are determined on a tax basis and may differ
from net investment income and realized capital gains for financial reporting
purposes.
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. 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 year ended October 31, 1999, 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. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At October 31, 1999, the fund had contributed capital of $70,000 to
Vanguard (included in Other Assets), representing 0.02% of the fund's net assets
and 0.1% 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 October 31, 1999, custodian fee offset arrangements reduced expenses
by $3,000.
E. During the year ended October 31, 1999, the fund purchased $39,926,000 of
investment securities and sold $72,225,000 of investment securities, other than
U.S. government securities and temporary cash investments. Sales of U.S.
government securities were $11,391,000.
17
<PAGE>
At October 31, 1999, the fund had available a capital loss carryforward of
$110,000 to offset future net capital gains through October 31, 2007.
F. At October 31, 1999, net unrealized depreciation of investment securities for
financial reporting and federal income tax purposes was $8,356,000, consisting
of unrealized gains of $6,220,000 on securities that had risen in value since
their purchase and $14,576,000 in unrealized losses on securities that had
fallen in value since their purchase.
18
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Trustees of
Vanguard Preferred Stock 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 Preferred Stock Fund (the "Fund") at October 31, 1999, 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 October 31, 1999 by
correspondence with the custodian, provide a reasonable basis for the opinion
expressed above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
November 30, 1999
19
<PAGE>
- --------------------------------------------------------------------------------
SPECIAL 1999 TAX INFORMATION (UNAUDITED) FOR
VANGUARD PREFERRED STOCK FUND
This information for the fiscal year ended October 31, 1999, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $4,518,000 as capital gain dividends (from net
long-term capital gains) to shareholders in December 1998, all of which is
designated as a 20% rate gain distribution.
For corporate shareholders, 100% of investment income (dividend income plus
short-term gains, if any) qualifies for the dividends-received deduction.
- --------------------------------------------------------------------------------
20
<PAGE>
- --------------------------------------------------------------------------------
THE PEOPLE WHO GOVERN YOUR FUND
The Trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are part owner of
the fund. Your fund Trustees also serve on the Board of Directors of The
Vanguard Group, which is owned by the funds and exists solely to provide
services to them on an at-cost basis.
Seven of Vanguard's nine board members are independent, meaning that they
have no affiliation with Vanguard or the funds they oversee, apart from the
sizable personal investments they have made as private individuals. They bring
distinguished backgrounds in business, academia, and public service to their
task of working with Vanguard officers to establish the policies and oversee the
activities of the funds.
Among board members' responsibilities are selecting investment advisers for
the funds; monitoring fund operations, performance, and costs; reviewing
contracts; nominating and selecting new Trustees/Directors; and electing
Vanguard officers.
The list below provides a brief description of each Trustee's professional
affiliations. Noted in parentheses is the year in which the Trustee joined the
Vanguard Board.
TRUSTEES
JOHN C. BOGLE (1967) 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 (1987) 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.
JOANN HEFFERNAN HEISEN (1998) Vice President, Chief Information Officer, and a
member of the Executive Committee of Johnson & Johnson; Director of Johnson &
JohnsonoMerck Consumer Pharmaceuticals Co., The Medical Center at Princeton, and
Women's Research and Education Institute.
BRUCE K. MACLAURY (1990) President Emeritus of The Brookings Institution;
Director of American Express Bank Ltd., The St. Paul Companies, Inc., and
National Steel Corp.
BURTON G. MALKIEL (1977) 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 Select Sector SPDR
Trust.
ALFRED M. RANKIN, JR. (1993) Chairman, President, Chief Executive Officer, and
Director of NACCO Industries, Inc.; Director of The BFGoodrich Co.
JOHN C. SAWHILL (1991) 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. (1971) 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 (1985) Retired Chairman 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.
VANGUARD MANAGING DIRECTORS
R. GREGORY BARTON Legal Department.
ROBERT A. DISTEFANO Information Technology.
JAMES H. GATELY Individual Investor Group.
KATHLEEN C. GUBANICH Human Resources.
IAN A. MACKINNON Fixed Income Group.
F. WILLIAM MCNABB, III Institutional Investor Group.
MICHAEL S. MILLER Planning and Development.
RALPH K. PACKARD Chief Financial Officer.
GEORGE U. SAUTER Core Management Group.
<PAGE>
ABOUT OUR COVER
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reproduction of Leading the Way, a 1984 work created
and copyrighted by noted naval artist Tom Freeman,
of Forest Hill, Maryland.
All comparative mutual fund data are from Lipper Inc. or Morningstar,
Inc., unless otherwise noted.
"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.
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This report is intended for the fund's
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Q380-12/13/1999
(C) 1999 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing
Corporation, Distributor.
