<PAGE> 1
VANGUARD
EQUITY INCOME
FUND
Semiannual Report
March 31, 1997
[THE VANGUARD GROUP LOGO]
<PAGE> 2
THE VANGUARD GROUP:
LINKING TRADITION
AND INNOVATION
[PHOTO]
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 Advisers
5
Performance
Summary
6
Financial
Statements
7
Directors And
Officers
INSIDE BACK COVER
All comparative mutual fund data are from Lipper Analytical Services, Inc. or
Morningstar unless otherwise noted.
<PAGE> 3
[PHOTO]
FELLOW SHAREHOLDER,
During the past six months, Vanguard Equity Income Fund provided a strong
total return of +11.3%, comfortably outpacing the return of the average equity
income mutual fund and eking out a tiny advantage over the unmanaged Standard &
Poor's 500 Composite Stock Price Index.
The following table compares the Fund's six-month total return (capital
change plus reinvested dividends) with those of the S&P 500 Index--dominated by
large, blue-chip stocks--and the average equity income mutual fund. We note that
the S&P 500 Index, which contains both growth and value stocks, is not a perfect
standard of comparison for the Fund, which emphasizes income-oriented value
stocks. Over the past six months, however, value stocks slightly outperformed
growth stocks, giving our Fund a bit of an edge versus the Index.
<TABLE>
<CAPTION>
- --------------------------------------------
TOTAL RETURN
SIX MONTHS ENDED
MARCH 31, 1997
- --------------------------------------------
<S> <C>
Vanguard Equity Income Fund +11.3%
- --------------------------------------------
Average Equity Income Fund + 9.4%
- --------------------------------------------
S&P 500 Index +11.2%
- --------------------------------------------
</TABLE>
Our Fund's return is based on an increase in net asset value from $17.69
per share on September 30, 1996, to $18.72 per share on March 31, 1997, with the
latter figure adjusted for the reinvestment of two quarterly dividends totaling
$0.36 per share from net investment income, and for distributions of $0.58 per
share from net capital gains realized during 1996.
THE PERIOD IN REVIEW
The stock market continued to advance during the first six months of Vanguard
Equity Income Fund's fiscal year, but the ride was bumpy. Fueled by moderate
economic growth, higher corporate earnings, and little sign of inflation, the
S&P 500 Index rose more than +10% during the first two months of the period. But
after a dip in December and then a strong January, the stock market remained
flat in February and declined -4.1% in March, largely a response to the growing
fear of inflation and higher interest rates.
The bond market shared in the volatility. The yield on the benchmark
30-year U.S. Treasury bond started the period on a downward path, falling from
6.92% on September 30, 1996, to 6.35% on November 30. But from there, the long
bond's yield rose steadily, ending the six-month period at 7.10%. Partly
responsible for the increase was the Federal Reserve Board's decision to raise
short-term interest rates by 25 basis points (0.25%).
For our Fund, the period was an excellent one in both absolute and relative
terms. While our traditional heavy stake in the lagging utility group and our
near-complete avoidance of the solidly performing technology sector impeded our
performance versus the S&P 500 Index, our considerable success in the bank and
Ffinance group and in the market-leading integrated oils sector more than made
up the difference.
We believe that our advantage over our average competitor lies in our
dedication to remaining a "pure" equity income portfolio. As such, we typically
keep a higher percentage of the Fund's assets in common stocks than do our
peers, who tend to hold bigger stakes in convertible bonds and preferred
stocks--higher-yielding securities that tend to lag long-
1
<PAGE> 4
term equity returns. And, of course, our far lower expenses (0.42% of average
net assets in fiscal 1996, versus 1.40% for our average competitor) provide a
significant head start.
Since December 31, 1994, our strategy of emphasizing dividend-paying common
stocks and seeking an average stock yield well above that of the S&P 500 Index
has been implemented through a multimanager structure using three advisers. The
table at left shows the Fund's allocation to each adviser as of March 31, 1997.
<TABLE>
<CAPTION>
- -------------------------------------------------------
TOTAL ASSETS MANAGED
--------------------
$ MILLION PERCENT
- -------------------------------------------------------
<S> <C> <C>
Newell Associates $ 975 65%
John A. Levin & Co., Inc. 233 15
Spare, Kaplan, Bischel & Associates 228 15
Cash Reserves 83 5
- -------------------------------------------------------
Total $1,519 100%
- -------------------------------------------------------
</TABLE>
The fits and starts experienced by the stock market over the past two
months have served as a crystal-clear reminder that volatility is, indeed, a
two-way street. Fortunately, for long-term investors who maintain a balanced
portfolio of stock funds, bond funds, and money market investments, short-term
market fluctuations are relatively unimportant. What is truly important for
investors to remember is that the financial markets are always subject to
turbulence and that a balanced investment program--thoughtfully constructed and
steadfastly maintained--is a strong ally in withstanding these inevitable ups
and downs.
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
April 15, 1997
2
<PAGE> 5
[PHOTO]
THE MARKETS IN PERSPECTIVE
SIX MONTHS ENDED MARCH 31, 1997
U.S. EQUITY MARKETS
Three key ingredients continued to provide the foundation for the U.S. stock
market's solid performance during the past six months: moderate economic growth,
quiescent inflation, and solid increases in corporate profits. Concern grew that
continued economic expansion could lead to higher inflation, although as of the
period's end there was no confirmed sign that inflation had increased. The
result has been an erratic upward drift in interest rates amid continued 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 11.2% over the six-month period, compared to a -0.2% loss for
the Russell 2000 Index. 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 more foreign sales for the biggest firms.
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 15.0% while those in the
Russell 2000 Index have dropped -15.3%. In health care, the S&P's holdings
gained 9.7%, compared to a decline of -11.9% 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.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
TOTAL RETURNS
PERIODS ENDED MARCH 31, 1997
----------------------------
6 MONTHS 1 YEAR 5 YEARS*
- -----------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 11.2% 19.8% 16.4%
Russell 2000 Index -0.2 5.1 12.8
MSCI-EAFE Index 0.1 1.8 10.9
- -----------------------------------------------------------------
FIXED-INCOME
Lehman Aggregate Bond Index 2.4% 4.9% 7.2%
Lehman 10-Year Municipal
Bond Index 2.8 5.2 7.5
Salomon 90-Day U.S. Treasury Bills 3.1 5.2 4.4
- -----------------------------------------------------------------
OTHER
Consumer Price Index 1.4% 2.8% 2.8%
- -----------------------------------------------------------------
*Average annual.
</TABLE>
Financial-service firms, by contrast, have generally fared well regardless
of size, with gains of 16.6% in the S&P 500 Index and 13.2% in the Russell 2000
Index since September. 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. It's worth noting, however, that financial services was the
S&P's worst-performing sector (-7.1%) during March's -4.1% decline. This
weakness reflects concern that the Federal Reserve's recent interest rate
increase may lead to narrower profit margins for lenders.
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 October
and November,
3
<PAGE> 6
investors seemed to expect a slowing of growth, and the 10-year U.S. Treasury's
yield declined from 6.70% to 6.04% at the end of November. 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, only to fall to 6.26% in mid-February. Then
the consensus shifted once again, and renewed expectations of higher inflation
pushed the 10-year's yield to 6.90% at the end of March.
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 past six months have witnessed
several such shifts, culminating in the Federal Reserve's decision to increase
its target federal funds rate from 5.25% to 5.50% on March 25, due to concerns
about strong growth in demand across the economy.
The net result for bond investors has been mediocre returns. The 2.4%
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
- -1.0%, reflecting the modest increase in interest rates. During this period,
investors who favored shorter-maturity and higher-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 8% to 13% 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 appreciated 5% against the
dollar.) The Morgan Stanley Capital International-Europe, Australasia, Far East
Index gained a mere 0.1% in dollar terms, while in local terms the return was
6.7%. Those who favored Europe over the Pacific region did not feel the pain as
much, due to the strong (21.0%) return generated by the local markets. For U.S.
investors, European markets provided 15.1%. 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 the
aggregate return for this region was -9.4% in local currency and -16.3% in
dollars. The primary source of the weakness was Japan, whose market fell -13.2%,
producing a -21.9% 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.
4
<PAGE> 7
[PHOTO]
REPORT FROM THE ADVISERS
Vanguard Equity Income Fund held its own as the stock market continued to
advance during the six months ended March 31, the first half of fiscal 1997. The
Fund's 11.3% total return exceeded the returns of both the average equity income
fund and the Standard & Poor's 500 Composite Stock Price Index.
The Fund's strategy of investing in stocks with relatively high dividend
yields in comparison with the overall market meant that we did not meaningfully
participate during the past two years in some of the hottest-performing market
sectors, such as technology stocks. For this reason, we trailed the returns on
the S&P 500 Index during this span. But volatility is a two-sided coin, and the
market's downturn late in our fiscal half-year demonstrated the flip side. From
its record high close on February 18 through March 31, the S&P 500 Index
provided a total return of -7.0%. During the same six weeks, the defensive
nature of high-yielding stocks was apparent; your Fund's total return was -5.1%.
For the six months, the Fund's best-performing holdings were in the
petroleum, banking, telephone, and health-care sectors. Petroleum stocks, the
biggest contributors to our performance in the period, benefited from
surprisingly strong earnings. Their robust balance sheets and relatively high
dividend yields continue to make petroleum companies attractive. Although we
have taken profits on some of our financial stocks, we believe that many banking
companies will continue to boost their earnings even in the face of a moderate
increase in interest rates.
Telephone stocks, whose prices were depressed by the real and perceived
threats of deregulation and intensifying competition, rallied late in the
period. The group seems to have much greater potential for earnings growth than
the market gave it credit for as recently as six months ago.
Electric utilities, in which your Fund has a substantial stake, continue to
struggle against the uncertainties of deregulation and were our worst-performing
sector. But we believe that the stronger utility companies will do well in the
coming competitive environment. Indeed, some of them already are showing
substantial progress. However, we think that the progress will not necessarily
be quick and certainly will not be easy for all utilities.
During the period, we added to the Fund's holdings of stocks sensitive to
the economy's ups and downs. Dividend yields on these cyclical stocks--notably
auto companies--have become more attractive in comparison with the overall
market.
We believe your Fund is well-positioned for the remainder of fiscal 1997
and beyond.
Newell Associates
John A. Levin & Co., Inc.
Spare, Kaplan, Bischel & Associates
April 14, 1997
INVESTMENT PHILOSOPHY
The advisers believe that a portfolio made up of undervalued stocks, most of
which offer high dividend yields compared to their past levels and to the
overall market, can provide a high level of current income, the potential for
capital appreciation, and below-average price volatility for a stock mutual
fund.
5
<PAGE> 8
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.
EQUITY INCOME FUND
TOTAL INVESTMENT RETURNS: MARCH 21, 1988-MARCH 31, 1997
<TABLE>
<CAPTION>
- ---------------------------------------------
EQUITY INCOME FUND S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ---------------------------------------------
<S> <C> <C> <C> <C>
1988 5.8% 2.5% 8.3% 3.2%
1989 23.8 5.0 28.8 33.0
1990 -20.5 4.3 -16.2 -9.2
1991 18.0 8.5 26.5 31.2
1992 6.4 5.9 12.3 11.1
1993 14.1% 5.1% 19.2% 13.0%
1994 -6.5 4.3 -2.2 3.7
1995 19.8 5.0 24.8 29.7
1996 14.2 4.0 18.2 20.3
1997* 9.2 2.1 11.3 11.2
- ---------------------------------------------
</TABLE>
*Six months ended March 31, 1997.
See Financial Highlights table on page 12 for dividend and capital gains
information for the past five years.
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED MARCH 31, 1997
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
SINCE INCEPTION
INCEPTION ----------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Equity Income Fund 3/21/88 17.31% 15.63% 8.46% 5.19% 13.65%
- -----------------------------------------------------------------------------------------
</TABLE>
6
<PAGE> 9
[PHOTO]
FINANCIAL STATEMENTS
MARCH 31, 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 (common stocks, preferred stocks, bonds,
etc.) and by industry sector. Other assets are added to, and liabilities are
subtracted from, the value of Total Investments to calculate the Fund's Net
Assets. Finally, Net Assets are divided by the outstanding shares of the Fund to
arrive at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying
the composition of the Fund's net assets on both a dollar and per-share basis.
Because all income and any realized gains must be distributed to shareholders
each year, the bulk of net assets consists of Paid in Capital (money invested by
shareholders). The amounts shown for Undistributed Net Investment Income and
Accumulated Net Realized Gains usually approximate the sums the Fund had
available to distribute to shareholders as income dividends or capital gains as
of the statement date. Any Accumulated Net Realized Losses, and any cumulative
excess of distributions over net income or net realized gains, will appear as
negative balances. Unrealized Appreciation (Depreciation) is the difference
between the market value of the Fund's investments and their cost, and reflects
the gains (losses) that would be realized if the Fund were to sell all of its
investments at their statement-date values.
<TABLE>
<CAPTION>
- ---------------------------------------------------------
MARKET
VALUE*
EQUITY INCOME FUND SHARES (000)
- ---------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (90.4%)
- ---------------------------------------------------------
AUTO & TRANSPORTATION (2.4%)
Burlington Northern
Santa Fe Corp. 37,359 $ 2,765
Ford Motor Co. 488,500 15,327
General Motors Corp. 55,900 3,095
Genuine Parts Co. 132,500 6,178
Norfolk Southern Corp. 37,500 3,197
Union Pacific Corp. 94,500 5,363
--------
35,925
--------
CONSUMER DISCRETIONARY (5.0%)
Avon Products, Inc. 38,700 2,032
Black & Decker Corp. 111,100 3,569
Deluxe Corp. 199,100 6,446
Eastman Kodak Co. 53,650 4,071
# Kmart Corp. 509,200 6,174
May Department Stores Co. 203,200 9,246
The McGraw-Hill Cos. 99,200 5,072
J.C. Penney Co., Inc. 401,300 19,112
Reader's Digest Assn., Inc.
Class A 62,000 1,783
Tribune Co. 148,000 5,994
Tupperware Corp. 78,100 2,616
Wal-Mart Stores, Inc. 148,400 4,137
Whirlpool Corp. 55,400 2,638
# Woolworth Corp. 114,600 2,679
--------
75,569
--------
CONSUMER STAPLES (9.0%)
American Brands, Inc. 530,500 26,856
Anheuser-Busch Cos., Inc. 126,800 5,341
The Clorox Co. 62,000 6,952
The Coca-Cola Co. 40,000 2,235
General Mills, Inc. 161,300 10,021
H.J. Heinz Co. 283,800 11,210
International Flavors &
Fragrances, Inc. 118,700 5,193
Kellogg Co. 58,700 3,948
Philip Morris Cos., Inc. 333,650 38,078
The Quaker Oats Co. 152,000 5,548
RJR Nabisco Holdings Corp. 60,000 1,935
Tambrands, Inc. 234,900 10,071
UST Inc. 341,000 9,505
--------
136,893
--------
FINANCIAL SERVICES (16.6%)
Aetna Inc. 47,200 4,053
American Express Co. 37,800 2,263
American General Corp. 333,900 13,606
Banc One Corp. 315,750 12,551
Bankers Trust New York Corp. 154,000 12,628
Barnett Banks, Inc. 148,800 6,919
Citicorp 30,500 3,302
CoreStates Financial Corp. 272,700 12,953
The Dun & Bradstreet Corp. 334,900 8,498
First Chicago NBD Corp. 152,900 8,276
First Union Corp. 109,400 8,875
Fleet Financial Group, Inc. 127,200 7,282
Great Western Financial Corp. 365,700 14,765
KeyCorp 125,700 6,128
Lincoln National Corp. 352,900 18,880
Marsh & McLennan Cos., Inc. 103,900 11,767
Meditrust 80,000 2,980
Mellon Bank Corp. 212,450 15,456
</TABLE>
7
<PAGE> 10
<TABLE>
<CAPTION>
- ---------------------------------------------------------
MARKET
VALUE*
EQUITY INCOME FUND SHARES (000)
- ---------------------------------------------------------
<S> <C> <C>
J.P. Morgan & Co., Inc. 209,100 $ 20,544
National City Corp. 34,000 1,585
NationsBank Corp. 260,118 14,404
PNC Bank Corp. 373,400 14,936
SAFECO Corp. 173,900 6,956
St. Paul Cos., Inc. 48,800 3,166
Sizzlers Property Investors, Inc. 57,500 597
U.S. Bancorp 126,600 6,773
Unitrin Inc. 81,800 4,070
USLIFE Corp. 40,400 1,889
Wachovia Corp. 103,600 5,646
--------
251,748
--------
HEALTH CARE (10.4%)
Allegiance Corp. 63,200 1,398
American Home Products Corp. 457,600 27,456
Baxter International, Inc. 222,400 9,591
Bristol-Myers Squibb Co. 684,500 40,385
# CIBA Specialty Chemicals 36,400 1,474
# Covance, Inc. 24,200 390
Glaxo Wellcome PLC ADR 351,400 12,431
Eli Lilly & Co. 257,100 21,146
Merck & Co., Inc. 167,800 14,137
Pharmacia & Upjohn, Inc. 598,425 21,917
Warner-Lambert Co. 88,300 7,638
--------
157,963
--------
INTEGRATED OILS (13.7%)
Amoco Corp. 262,000 22,696
Atlantic Richfield Co. 226,100 30,523
Chevron Corp. 426,500 29,695
Exxon Corp. 349,600 37,669
Mobil Corp. 201,800 26,360
Phillips Petroleum Co. 112,000 4,578
Royal Dutch Petroleum Co. ADR 63,200 11,060
Texaco Inc. 353,400 38,697
USX-Marathon Group 259,000 7,220
--------
208,498
--------
OTHER ENERGY (0.1%)
McDermott International, Inc. 60,000 1,283
# Oryx Energy Co. 50,000 962
--------
2,245
--------
MATERIALS & PROCESSING (5.7%)
ARCO Chemical Co. 123,700 5,381
Allegheny Teledyne Inc. 247,300 6,955
BetzDearborn Inc. 21,700 1,370
Consolidated Papers 4,500 235
Corning, Inc. 121,600 5,396
Dow Chemical Co. 280,600 22,448
E.I. du Pont de Nemours & Co. 89,200 9,455
International Paper Co. 95,000 3,693
Lubrizol Corp. 66,600 2,165
Monsanto Co. 60,500 2,314
Potlatch Corp. 163,600 6,728
Union Camp Corp. 149,800 7,059
Weyerhaeuser Co. 230,700 10,295
Witco Chemical Corp. 72,900 2,479
--------
85,973
--------
PRODUCER DURABLES (1.8%)
Emerson Electric Co. 78,700 3,542
Honeywell, Inc. 43,400 2,946
Lockheed Martin Corp. 44,900 3,772
Pitney Bowes, Inc. 84,300 4,953
Thomas & Betts Corp. 117,200 5,010
WMX Technologies Inc. 212,800 6,517
--------
26,740
--------
TECHNOLOGY (1.0%)
Electronic Data Systems Corp. 74,778 3,019
General Motors Corp. Class H 56,100 3,043
International Business
Machines Corp. 25,100 3,448
# U S WEST Media Group 124,000 2,309
Varian Associates, Inc. 54,700 2,926
--------
14,745
--------
UTILITIES (22.3%)
AT&T Corp. 435,700 15,141
Allegheny Power System, Inc. 433,700 12,848
Ameritech Corp. 352,500 21,679
Baltimore Gas & Electric Co. 353,600 9,459
Bell Atlantic Corp. 337,600 20,551
BellSouth Corp. 319,500 13,499
Central & South West Corp. 451,500 9,651
Consolidated Edison Co. of
New York, Inc. 130,700 3,921
Consolidated Natural Gas Co. 300,800 15,153
Dominion Resources, Inc. 124,300 4,521
Duke Power Co. 179,000 7,898
Edison International 397,100 8,935
# Energy Group PLC ADR 76,737 2,465
FPL Group, Inc. 86,200 3,803
GTE Corp. 645,300 30,087
Long Island Lighting Co. 29,100 698
NICOR, Inc. 227,900 7,293
Northeast Utilities 166,700 1,313
Northern States Power Co. 68,700 3,255
NYNEX Corp. 544,450 24,840
OGE Energy Corp. 170,700 7,148
PECO Energy Corp. 43,000 876
PP&L Resources Inc. 234,000 4,739
Pacific Enterprises 102,300 3,095
Pacific Telesis Group 307,200 11,597
PacifiCorp 467,000 9,982
Potomac Electric Power Co. 196,400 4,812
Public Service Co. of Colorado 56,200 2,178
Public Service Enterprise
Group Inc. 314,600 8,258
SCANA Corp. 190,600 4,836
Southern Co. 238,500 5,038
Southern New England
Telecommunications Corp. 99,800 3,580
TECO Energy, Inc. 214,900 5,158
Texas Utilities Co. 198,500 6,799
Union Electric Co. 285,700 10,535
U S WEST Communications
Group 663,050 22,544
Western Resources, Inc. 64,000 1,920
Wisconsin Energy Corp. 408,300 10,003
--------
340,108
--------
OTHER (2.4%)
Cooper Industries, Inc. 91,000 3,947
General Electric Co. 108,100 10,729
Hanson PLC ADR 76,737 1,746
</TABLE>
8
<PAGE> 11
<TABLE>
<CAPTION>
- ---------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ---------------------------------------------------------
<S> <C> <C>
Minnesota Mining &
Manufacturing Co. 148,400 $ 12,540
Ogden Corp. 340,700 7,197
----------
36,159
----------
- ---------------------------------------------------------
TOTAL COMMON STOCKS
(COST $975,318) 1,372,566
- ---------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (2.1%)
- ---------------------------------------------------------
Aetna Inc. Cvt. 6.25% 27,000 2,221
AirTouch Communications, Inc.
Cvt. 6.00% 140,000 3,588
Atlantic Richfield Co. Cvt. 9.00%
(Convertible into Lyondell
Petrochemical Co.) 160,000 3,520
Crown Cork & Seal Co., Inc.
Cvt. 4.50% 110,000 5,335
Federal Mogul Corp. Cvt. $3.875 15,000 1,020
Globalstar Telecommunications
Ltd. Cvt. 6.50% 76,100 3,957
Host Marriott Corp. Cvt. 6.75% 75,000 4,219
Loral Space & Communications
Ltd. Cvt. 6.00% 40,000 1,930
McDermott International, Inc.
Cvt. $2.875 17,500 735
# USAirways Group Inc. Cvt. $4.375 28,000 2,076
Westinghouse Electric Corp.
Cvt. $1.30 160,000 2,580
- ---------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(COST $29,735) 31,181
- ---------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
- ---------------------------------------------------------
<S> <C> <C>
CONVERTIBLE BONDS (0.3%)
- ---------------------------------------------------------
Alza Corp.
5.00%, 5/1/06 $ 1,800 1,764
Equitable Cos., Inc.
6.125%, 12/15/24 1,236 1,443
Molten Metal Technology Inc.
5.50%, 5/1/06 1,290 697
Roche Holdings, Inc.
0.00%, 4/20/10 800 360
Time Warner Inc.
0.00%, 12/17/12 2,600 982
- ---------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(COST $5,942) 5,246
- ---------------------------------------------------------
TEMPORARY CASH INVESTMENT (7.0%)
- ---------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account 6.35%, 4/1/97
(COST $106,872) 106,872 106,872
- ---------------------------------------------------------
TOTAL INVESTMENTS (99.8%)
(COST $1,117,867) 1,515,865
- ---------------------------------------------------------
OTHER ASSETS AND LIABILITIES (0.2%)
- ---------------------------------------------------------
Other Assets--Notes C and F $ 18,152
Liabilities--Note F (14,964)
---------
3,188
- ---------------------------------------------------------
NET ASSETS (100%)
- ---------------------------------------------------------
Applicable to 81,126,175 outstanding
$.001 par value shares
(authorized 1,000,000,000 shares) $1,519,053
=========================================================
NET ASSET VALUE PER SHARE $18.72
=========================================================
</TABLE>
*See Note A in Notes to Financial Statements.
#Non-Income Producing Security.
ADR--American Depository Receipt.
- ---------------------------------------------------------
AT MARCH 31, 1997, NET ASSETS CONSISTED OF:
- ---------------------------------------------------------
<TABLE>
<CAPTION>
AMOUNT PER
(000) SHARE
- ---------------------------------------------------------
<S> <C> <C>
Paid in Capital $1,071,503 $13.21
Undistributed Net
Investment Income 10,696 .13
Accumulated Net
Realized Gains 38,856 .48
Unrealized Appreciation--
Note E 397,998 4.90
- ---------------------------------------------------------
NET ASSETS $1,519,053 $18.72
=========================================================
</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>
- ----------------------------------------------------------------------------------------
EQUITY INCOME FUND
SIX MONTHS ENDED MARCH 31, 1997
(000)
- ----------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 24,348
Interest 2,858
--------
Total Income 27,206
--------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 1,274
Performance Adjustment (138)
The Vanguard Group--Note C
Management and Administrative 1,384
Marketing and Distribution 152
Taxes (other than income taxes) 50
Custodian Fees 24
Auditing Fees 7
Shareholders' Reports 32
Annual Meeting and Proxy Costs 6
Directors' Fees and Expenses 2
--------
Total Expenses 2,793
Expenses Paid Indirectly--Note C (49)
--------
Net Expenses 2,744
- ----------------------------------------------------------------------------------------
NET INVESTMENT INCOME 24,462
- ----------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 46,706
- ----------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 76,579
- ----------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $147,747
========================================================================================
</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>
- ----------------------------------------------------------------------------------------
EQUITY INCOME FUND
---------------------------
SIX MONTHS YEAR
ENDED ENDED
MAR. 31, 1997 SEP. 30, 1996
(000) (000)
- ----------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 24,462 $ 43,060
Realized Net Gain 46,706 37,039
Change in Unrealized Appreciation (Depreciation) 76,579 107,851
------------------------
Net Increase in Net Assets Resulting from Operations 147,747 187,950
------------------------
DISTRIBUTIONS
Net Investment Income (27,717) (41,545)
Realized Capital Gain (43,397) (10,870)
------------------------
Total Distributions (71,114) (52,415)
------------------------
NET EQUALIZATION CREDITS--Note A 1,019 2,104
------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 204,208 390,890
Issued in Lieu of Cash Distributions 64,210 46,196
Redeemed (136,398) (232,739)
------------------------
Net Increase from Capital Share Transactions 132,020 204,347
- ----------------------------------------------------------------------------------------
Total Increase 209,672 341,986
- ----------------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 1,309,381 967,395
------------------------
End of Period $1,519,053 $1,309,381
========================================================================================
(1)Shares Issued (Redeemed)
Issued 10,886 23,377
Issued in Lieu of Cash Distributions 3,519 2,725
Redeemed (7,301) (13,877)
------------------------
Net Increase in Shares Outstanding 7,104 12,225
========================================================================================
</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>
- ------------------------------------------------------------------------------------------------------------------------
EQUITY INCOME FUND
YEAR ENDED SEPTEMBER 30,
FOR A SHARE OUTSTANDING SIX MONTHS ENDED ------------------------------------------------------------
THROUGHOUT EACH PERIOD MARCH 31, 1997 1996 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $17.69 $15.65 $13.16 $14.62 $12.81 $12.14
- ------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .31 .63 .60 .59 .59 .59
Net Realized and Unrealized Gain (Loss)
on Investments 1.66 2.18 2.56 (.92) 1.81 .83
--------------------------------------------------------------------
Total from Investment Operations 1.97 2.81 3.16 (.33) 2.40 1.42
--------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.36) (.60) (.58) (.61) (.59) (.65)
Distributions from Realized Capital Gains (.58) (.17) (.09) (.52) -- (.10)
--------------------------------------------------------------------
Total Distributions (.94) (.77) (.67) (1.13) (.59) (.75)
- ------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $18.72 $17.69 $15.65 $13.16 $14.62 $12.81
========================================================================================================================
TOTAL RETURN 11.28% 18.22% 24.77% -2.19% 19.17% 12.26%
========================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $1,519 $1,309 $967 $901 $1,106 $778
Ratio of Total Expenses to
Average Net Assets 0.39%* 0.42% 0.47% 0.43% 0.40% 0.44%
Ratio of Net Investment Income to
Average Net Assets 3.39%* 3.69% 4.27% 4.41% 4.39% 4.74%
Portfolio Turnover Rate 23%* 21% 31% 18% 15% 13%
Average Commission Rate Paid $.0572 $.0598 N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
*Annualized.
12
<PAGE> 15
NOTES TO FINANCIAL STATEMENTS
Vanguard Equity Income Fund is registered under the Investment Company Act of
1940 as a diversified open-end investment company, or mutual fund.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The Fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Securities listed on an exchange are valued at the
latest quoted sales prices as of the close of trading on the New York Stock
Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such
securities not traded on the valuation date are valued at the mean of the latest
quoted bid and asked prices. Securities not listed on an exchange are valued at
the latest quoted bid prices. Temporary cash investments are valued at cost,
which approximates market value.
2. FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. EQUALIZATION: The Fund follows 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, is credited or charged to undistributed income. As a
result, undistributed income per share is unaffected by capital share
transactions.
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. Under investment advisory contracts, the Fund pays Newell Associates; Spare,
Kaplan, Bischel & Associates; and John A. Levin & Co., Inc., advisory fees
calculated at an annual percentage rate of average net assets. The basic fees
thus computed for Spare, Kaplan, Bischel & Associates are subject to quarterly
adjustments based on performance relative to the S&P/BARRA Value Index; such
fees for John A. Levin & Co., Inc., are subject to quarterly adjustments based
on performance relative to the S&P 500 Index. For the six months ended March 31,
1997, the aggregate advisory fee represented an effective annual basic rate of
0.18% of the Fund's average net assets before a decrease of $138,000 (an annual
rate of 0.02%) based on performance.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the Fund under methods approved by the board of directors. At March 31, 1997,
the Fund had contributed capital of $130,000 to Vanguard (included in Other
Assets), representing 0.7% of Vanguard's capitalization. The Fund's directors
and officers are also directors and officers of Vanguard.
Vanguard has asked the Fund's investment advisers to direct certain
portfolio trades, subject to obtaining the best price and execution, to brokers
who have agreed to rebate to the Fund part of the commissions generated. Such
rebates are used solely to reduce the Fund's administrative expenses. For the
six months ended March 31, 1997, these arrangements reduced the Fund's expenses
by $49,000 (an annual rate of 0.01% of average net assets).
13
<PAGE> 16
D. During the six months ended March 31, 1997, the Fund purchased $223,819,000
of investment securities and sold $157,040,000 of investment securities other
than U.S. government securities and temporary cash investments.
E. At March 31, 1997, net unrealized appreciation of investment securities for
financial reporting and federal income tax purposes was $397,998,000, consisting
of unrealized gains of $413,543,000 on securities that had risen in value since
their purchase and $15,545,000 in unrealized losses on securities that had
fallen in value since their purchase.
F. The market value of securities on loan to broker/dealers at March 31, 1997,
was $3,577,000, for which the Fund held cash collateral of $3,769,000.
14
<PAGE> 17
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman of the Board and Director
of The Vanguard Group, Inc. and of
each of the investment companies in
The Vanguard Group.
JOHN J. BRENNAN, President, Chief Executive Officer,
and Director of The Vanguard Group,
Inc. and of each of the investment
companies in The Vanguard Group.
ROBERT E. CAWTHORN, Chairman Emeritus and
Director of Rhone-Poulenc Rorer
Inc.; Director of Sun Company, Inc.
and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER, Director of The Great
Atlantic and Pacific Tea Co., Alco
Standard Corp., Raytheon Co.,
Knight-Ridder, Inc., and Massa-
chusetts Mutual Life Insurance Co.;
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.
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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Portfolio
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(CA, NJ, OH, PA)
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(CA, FL, NJ, NY, OH, PA)
Q652-3/97
