<PAGE> 1
VANGUARD
EQUITY INCOME
FUND
Annual Report - September 30, 1997
[PHOTO]
[THE VANGUARD GROUP LOGO]
<PAGE> 2
OUR CREW MAKES THE DIFFERENCE
Throughout our history, The Vanguard Group has received considerable attention
as the low-cost provider of mutual funds. While such accolades are gratifying,
we are most proud, not of our low operating expenses or the billions of dollars
we manage, but of our sterling reputation created by the Vanguard crew.
We recognize that it is our crew members--some 6,000 highly motivated
men and women--who form the cornerstone of our operations. As with any
cornerstone, we could not survive long--let alone prosper--without it. That's
why we chose this fiscal year's annual report to celebrate the spirit,
enthusiasm, and achievements of our crew. (We call those who work at Vanguard
crew members, not employees, because they operate as a team to accomplish our
mission of serving you, our clients.)
But while we prize the collective contributions of our crew, we also
take time to recognize the importance of the individual. Each calendar quarter,
we present our Award For Excellence to a handful of crew members who have
demonstrated particular excellence in the performance of their jobs and who
embody "The Vanguard Spirit." Our report cover shows only a few of the more
than 300 crew members who have received this distinction since 1984.
[PHOTO]
John C. Bogle
Chairman
[PHOTO]
John J. Brennan
Presdent
They, along with the rest of our valiant crew, look forward to serving
you in the years ahead.
<TABLE>
<CAPTION>
CONTENTS
<S> <C>
A MESSAGE TO OUR SHAREHOLDERS................. 1
THE MARKETS IN PERSPECTIVE.................... 4
REPORT FROM THE ADVISERS...................... 6
PORTFOLIO PROFILE............................. 8
PERFORMANCE SUMMARY........................... 10
FINANCIAL STATEMENTS.......................... 11
REPORT OF INDEPENDENT ACCOUNTANTS............. 19
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER,
Vanguard Equity Income Fund soared along with the high-flying U.S. stock market
in the fiscal year ended September 30, 1997, providing a remarkable return of
+34.2%.
The gain was the highest in the Fund's nine-and-a-half year lifetime and
precisely matched the return of the average equity income fund. However, it
fell short of the truly amazing performance of the Standard & Poor's 500
Composite Stock Price Index, which earned +40.4%. The table at right presents
the fiscal 1997 total returns (capital change plus reinvested dividends) of the
Fund, its average competitor, and the unmanaged S&P 500 Index. The Fund's total
return is based on net asset values of $17.69 per share on September 30, 1996,
and $22.28 per share on September 30, 1997, with the latter figure adjusted for
the reinvestment of four quarterly dividends totaling $0.64 per share from net
investment income and a distribution of $0.58 per share paid from net realized
capital gains.
<TABLE>
<CAPTION>
- -------------------------------------------------------
TOTAL RETURNS
FISCAL YEAR ENDED
SEPTEMBER 30, 1997
- -------------------------------------------------------
<S> <C>
Vanguard Equity Income Fund +34.2%
- -------------------------------------------------------
Average Equity Income Fund +34.2%
- -------------------------------------------------------
S&P 500 Index +40.4%
- -------------------------------------------------------
</TABLE>
FISCAL 1997 PERFORMANCE OVERVIEW
For the third year in a row, the U.S. stock market shot higher in the twelve
months ended September 30, bringing the three-year cumulative return of the S&P
500 Index to an incredible +119%. Economic conditions remained ideal for equity
investors, as business activity continued to rise without engendering increases
in inflation or long-term interest rates, and corporate profits continued to
burgeon. On balance during the year, the yield on the benchmark 30-year U.S.
Treasury bond declined by 0.49 percentage point to 6.43%. On the short-term
side, by contrast, rates eased upward, with the yield on the three-month U.S.
Treasury bill closing the fiscal year at 5.11%, up 0.08 percentage point from
the level on September 30, 1996. The general decline in long-term interest
rates raised bond prices by more than 6%, bringing total long-term bond returns
(including interest payments) to some 13%. This interest-rate environment,
along with the splendid economic fundamentals, elevated the already-high
spirits of investors, and by year-end stock prices were at or near historic
highs in relation to such fundamentals as dividends, earnings, and book values.
Our +34.2% return was marvelous on an absolute basis and, as noted, was
equal to that of the average equity income fund. The main reason for our
shortfall versus the S&P 500 Index was our near-absence from the technology
sector, which skyrocketed some 67% during the year. Technology stocks accounted
for about 13% of the Index's capitalization versus roughly 1% of the Fund's
assets. We also were hurt by our comparatively heavy weighting in utility
stocks (accounting for nearly 25% of the Fund, but less than 10% of the Index).
Utilities lagged the Index as a whole, providing a return of about +27%.
These large variations in our sector weightings from those of the S&P 500
Index are largely explained by our income objective. Technology stocks have
extremely low dividend yields, while utilities are among the market's
highest-yielding groups. Our modest cash reserve also put us at a disadvantage
compared with the Index; cash is a drag on performance in a rapidly rising
market, and the Index, as a theoretical construct, includes no cash.
1
<PAGE> 4
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
TOTAL ASSETS MANAGED
----------------------
$ MILLION PERCENT
- --------------------------------------------------------------------
<S> <C> <C>
Newell Associates $1,241 63%
John A. Levin & Company, Inc. 306 16
Spare, Kaplan, Bischel & Associates 302 16
Cash Reserves* 99 5
- --------------------------------------------------------------------
Total $1,948 100%
- --------------------------------------------------------------------
</TABLE>
*Each adviser also may maintain a modest cash reserve.
Since December 31, 1994, the Fund's investment policies have been
implemented by three advisers--Newell Associates; John A. Levin & Company; and
Spare, Kaplan, Bischel & Associates. The table at left shows their current
allocation of Fund assets.
We should note that Newell Associates, which has served as adviser for
the Fund since its inception, continues to manage the predominant portion of
our assets and turned in a particularly outstanding record during the year.
Just six months from now we will mark our tenth anniversary, and we thank the
Newell team for its achievements during our first decade.
LONG-TERM PERFORMANCE OVERVIEW
With nearly a decade of operations under its belt, Vanguard Equity Income Fund
has produced a very respectable record. Our average annual return is a full
percentage point higher than that of the average equity income fund over the
period. Our long-term edge over competing funds is largely explained by our
lower operating costs, which amounted to 0.45% of average net assets in fiscal
1997--nearly a percentage point below the 1.40% expense ratio of the average
equity income fund.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
TOTAL RETURNS
MAR. 21, 1988, TO SEP. 30, 1997
-------------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- ------------------------------------------------------------------------
<S> <C> <C>
Vanguard Equity Income Fund +15.1% $38,257
- ------------------------------------------------------------------------
Average Equity Income Fund +14.0% $34,739
- ------------------------------------------------------------------------
S&P 500 Index +17.5% $46,624
- ------------------------------------------------------------------------
</TABLE>
You will note that neither our Fund nor its peer group succeeded in
outpacing the S&P 500 Index. This phenomenon is largely explained by the
emphasis that equity income funds place on dividend-paying stocks with an
aggregate dividend yield well above that of the Index. Although that sort of
conservative strategy tends to lag in strong bull markets, it also has tended
to provide commensurate resistance in market downturns. Equity income funds
characteristically have lower risk (i.e., price volatility) than the Index or
the overall market, and their risk-adjusted returns have, in fact, been fully
competitive.
We emphasize that the Fund's returns since its inception in 1988 and the
returns of the stock market since that time have been extraordinarily high by
long-term historical standards and are no indication whatsoever of future
returns. Indeed, investors should bear in mind that stock market returns have
displayed a strong tendency to revert toward their long-term average (which is
under +11% annually for the U.S. stock market).
IN SUMMARY
The bull market in U.S. stocks that began 15 years ago has been especially
rewarding of late. Whereas equity investors have every reason to be thankful
for the stock market's bounty, they also have reason to be mindful of the
accompanying risks. With stock market valuations at high levels, the
ever-present risks of owning stocks are especially evident now.
2
<PAGE> 5
That said, the greatest risk of investing is not to invest in the first
place. We believe a sound method for dealing with risk is to construct a
balanced investment program-- including stock funds, bond funds, and cash
reserves--suited to your objectives, financial situation, tolerance for risk,
and time horizon. If you have such a program in place, you are prepared to
"stay the course" toward your investment goals.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Chairman of the Board President
October 13, 1997
3
<PAGE> 6
THE MARKETS IN PERSPECTIVE
Year Ended September 30, 1997
U.S. EQUITY MARKETS
For stock investors, the fiscal year ended September 30, 1997, was nothing
short of spectacular. Indeed, it was a very good year for almost all types of
investors: Virtually across the board, returns in the equity and bond markets
ranged from quite strong to exceptional, relative to historical averages. These
results can be attributed to three factors: continued solid economic growth;
harnessed inflation, remaining at levels not experienced since the 1960s; and
growth in corporate profits that was not only impressive but exceeded
expectations. The most surprising aspect of this remarkable period is that the
rate of inflation actually continued to decline despite robust growth and a
very low level of unemployment. According to traditional economic theory,
inflation should instead have accelerated at this point in the economic cycle.
The most widely accepted explanation for this paradox involves substantial
productivity gains that are not apparent from the measures in use today.
Reports indicate that even the Federal Reserve Board is otherwise at a loss to
explain the current "economic nirvana."
Large-capitalization U.S. common stocks performed extraordinarily well
during the past year, as illustrated by the 40.4% gain of the Standard & Poor's
500 Composite Stock Price Index. This advance ranks among the top 5% for all
12-month periods in the last 20 years. Among the best-performing sectors were
technology and financial services, with increases of 67.5% and 54.1%,
respectively. The surge in technology reflects robust corporate spending on
this industry's products, particularly desktop computers, networking equipment,
and software. Despite posting an aggregate gain of 24.4%, consumer
discretionary stocks could be considered laggards. (Clearly, the market has
shown amazing gains when a 24% advance over a one-year period can be viewed as
inadequate.)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED SEPTEMBER 30, 1997
-------------------------------------
1 YEAR 3 YEARS 5 YEARS
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 40.4% 29.9% 20.8%
Russell 2000 Index 33.2 23.0 20.5
MSCI EAFE Index 12.5 9.1 12.7
- ------------------------------------------------------------------------------
FIXED-INCOME
Lehman Aggregate Bond Index 9.7% 9.5% 6.9%
Lehman 10-Year Municipal Bond Index 9.5 8.7 7.4
Salomon Brothers Three-Month
U.S. Treasury Bill Index 5.2 5.4 4.6
- ------------------------------------------------------------------------------
OTHER
Consumer Price Index 2.2% 2.6% 2.7%
- ------------------------------------------------------------------------------
</TABLE>
The performance of small-company stocks, while they failed to match the
outsized advance of the S&P 500 Index, was more than respectable during this
period--the Russell 2000 Index gained 33.2%. The difference in return between
large and small companies is partly the result of the superior earnings growth
achieved by larger companies during the past 24 months. In addition, large
companies generated better-than-expected earnings 60% of the time over the past
year, compared to only 40% for small firms. Within sectors, the most dramatic
difference between large and small companies appeared in technology issues. In
the Russell 2000 Index, technology stocks advanced "only" 26.0% in aggregate,
over 40 percentage points less than their large-company counterparts.
4
<PAGE> 7
U.S. FIXED-INCOME MARKETS
In the fixed-income markets, rates fell across the yield curve, rewarding
investors with higher total returns. For example, the rates on 1-, 5-, 10-, and
30-year U.S. Treasury issues fell 0.25%, 0.47%, 0.58%, and 0.49%, respectively,
from September 30, 1996, to September 30, 1997. These declines reflect the
continued good news regarding inflation and the relative dormancy of the
Federal Reserve. The benefit of the drop in rates can be seen in the 9.7%
return of the Lehman Brothers Aggregate Bond Index, the broadest measure of
investment-grade issues. Investors in lower-quality securities fared even
better, as illustrated by the 14.5% gain of the Lehman High Yield Bond Index.
The strength of the economy combined with the lack of inflationary pressure
produced an ideal environment for junk bonds.
INTERNATIONAL EQUITY MARKETS
Investments in non-U.S. common stocks did not match the gains in domestic
equities, with the Morgan Stanley Capital International Europe, Australasia,
Far East Index advancing 12.5% in dollars. This Index's relatively modest
performance masks the fact that the European markets were very strong during
the past year, gaining 48.1% in local currency terms and 35.4% in dollars,
while many of the Pacific Basin markets were weak, down 5.4% in local currency
and 13.1% in dollars. The Japanese market declined 15.7% in dollars and 8.6% in
yen terms. Despite the competitive benefits of a weak currency, Japan continued
to struggle with a weak domestic economy and an oversupply of equities. Smaller
Asian markets, such as Malaysia (losing 28.5% in local terms and 44.7% in
dollars), suffered from a variety of challenges, chiefly overvalued currencies
and high interest rates.
5
<PAGE> 8
REPORT FROM THE ADVISERS
The fiscal year ended September 30, 1997, was the best ever for Vanguard
Equity Income Fund, as we achieved a total return of 34.2%. While we equaled the
return of the average equity income fund, we did not keep up with the breakneck
pace set by the Standard & Poor's 500 Composite Stock Price Index, which
returned 40.4%.
Every sector contributed double-digit gains to the Fund's return for
fiscal 1997, but, as always, there were significant differences among sectors.
Our strongest performers during the year were banking and insurance stocks in
the financial services sector, pharmaceuticals and other health-care stocks,
and energy and petroleum stocks. Before elaborating on these, we'll discuss the
two sectors that led to our shortfall versus the S&P 500 Index.
TECHNOLOGY AND UTILITIES
Our strategy of investing in relatively high-yielding stocks meant that your
Fund held almost no computer-related technology stocks, most of which are
inappropriate for the Fund because they pay little or no dividends. A list of
our largest holdings appears in the adjacent table. The lack of technology
holdings explains most of our underperformance relative to the Index, since
this was by far the hottest sector of the market, gaining nearly 70%. The
sector now accounts for roughly 13% of the capitalization of the S&P 500 Index
(up from less than 10% only five years ago), and thus is one of the most
powerful influences on the performance of the Index.
<TABLE>
<CAPTION>
- ----------------------------------------------------
TEN LARGEST STOCKS
- ----------------------------------------------------
PERCENTAGE
COMPANY OF NET ASSETS
- ----------------------------------------------------
<S> <C>
1. Bell Atlantic Corp. 3.0%
2. Bristol-Myers Squibb Co. 2.6
3. Exxon Corp. 2.3
4. Philip Morris Cos., Inc. 2.2
5. Texaco Inc. 2.2
6. Atlantic Richfield Co. 2.1
7. Chevron Corp. 2.0
8. U S WEST 1.8
9. GTE Corp. 1.7
10. American Home Products Corp. 1.7
- ----------------------------------------------------
</TABLE>
Some of the technology sector's increased influence is due simply to the
addition of companies to the Index, but much of it has resulted from the
spectacular rise in the prices of technology stocks. Whether these stocks will
continue to lead the market is far from clear. It is undeniably true that
technological innovation is proceeding at an extraordinary rate, but financial
results from the sector may not meet investors' high expectations. Competition
in the sector is intense, free cash flows are modest for many enterprises, and
the life cycles of products are quite short.
Another reason the Fund lagged the Index during the fiscal year was our
sizable weighting in utility stocks, which account for nearly a quarter of our
assets versus about 10% for the Index. Returns on utilities were quite good by
normal standards, but were significantly lower than the astonishing return of
the Index overall. Although electric utilities in particular have continued to
disappoint, thorough analysis still indicates that the sector is
6
<PAGE> 9
attractive. In its concern over prospects of electric utilities, the market is
painting the entire industry with the same brush, without properly
discriminating in its valuation of the various players. We have been buying
utilities that should flourish in the newly emerging deregulated environment.
Among our additions were Allegheny Energy, Duke Energy, and Florida Progress. We
expect electric utilities to improve their relative showing over the next 6 to
12 months as state and federal regulators clarify the rules of the road for the
industry.
STRONG PERFORMERS
Attractive opportunities can be found among relatively high-yielding stocks in
most industry groups, as reflected in the broad diversification of the Fund's
holdings. As mentioned earlier, the strongest contributors to the Fund's
results in fiscal 1997 were our holdings of financial services, health-care,
and petroleum-related stocks.
The strong performance of banks continued a five-year trend produced by
generally lower interest rates and favorable regulatory policies. We took some
profits on financial stocks, but we remain overweighted in this sector versus
the Index.
Health-care stocks--particularly the major drug companies--enjoyed
strong price appreciation. These stocks, most of which we bought after they
fell out of favor because of fears of national health-insurance legislation,
have recovered much of their reputation for growth in the eyes of investors.
Although we have sold some of our holdings in this group, the dividend yields
of several others remain high enough to keep them in the Fund under our
relative-yield discipline.
Petroleum stocks performed well because oil prices and demand for energy
remained higher than many market participants had expected. Yields are still
relatively attractive in this sector, and the Fund's weighting in integrated
oil companies is nearly twice that of the Index.
The Fund remains underweighted in the consumer staples sector, where,
after several years of outstanding share-price increases, many of the popular
large-capitalization, multinational companies have yields that remain at or
near historic lows. In recent months, the market has begun to question
valuations of some of these classic stocks, such as Coca-Cola and Gillette. The
apt question is whether consumer-product companies can continue to generate
rapid earnings growth when revenue growth is generally confined to single-digit
rates.
Some of the factors that have fueled this extended bull market may be
changing. Companies have already achieved substantial reductions in their
operating costs, and price pressures are intense in many industries, so
earnings gains may be increasingly difficult to sustain. Even so, we are still
able to find stocks that appear attractive and offer above-average capital
protection. These stocks, we believe, put the Fund in a position to capture an
important share of market advances. In the market downturns that are inevitable
from time to time, we expect the relatively high yield of the Fund's holdings
to provide some cushioning effect.
Newell Associates
John A. Levin & Co., Inc.
Spare, Kaplan, Bischel & Associates
October 10, 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.
7
<PAGE> 10
PORTFOLIO PROFILE
Equity Income Fund
This Profile provides a snapshot of the Fund's characteristics as of September
30, 1997, compared where appropriate to an unmanaged index. Key elements of
this Profile are defined on page 9.
PORTFOLIO CHARACTERISTICS
<TABLE>
<CAPTION>
- ----------------------------------------------------------
EQUITY INCOME S&P 500
- ----------------------------------------------------------
<S> <C> <C>
Number of Stocks 163 500
Median Market Cap $18.5B $35.4B
Price/Earnings Ratio 18.5x 21.9x
Price/Book Ratio 3.1x 4.0x
Yield 2.9% 1.6%
Return on Equity 18.2% 20.3%
Earnings Growth Rate 9.3% 18.2%
Foreign Holdings 1.3% 2.1%
Turnover Rate 22% --
Expense Ratio 0.45% --
Cash Reserves 6.2% --
</TABLE>
INVESTMENT FOCUS
- ----------------------------------------------------------
[CHART]
VOLATILITY MEASURES
<TABLE>
<CAPTION>
- ----------------------------------------------------------
EQUITY INCOME S&P 500
- ----------------------------------------------------------
<S> <C> <C>
R-Squared 0.85 1.00
Beta 0.70 1.00
- ----------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST STOCKS (% OF TOTAL NET ASSETS)
- --------------------------------------------------------
<S> <C>
Bell Atlantic Corp. 3.0%
Bristol-Myers Squibb Co. 2.6
Exxon Corp. 2.3
Philip Morris Cos., Inc. 2.2
Texaco Inc. 2.2
Atlantic Richfield Co. 2.1
Chevron Corp. 2.0
U S WEST 1.8
GTE Corp. 1.7
American Home Products Corp. 1.7
- --------------------------------------------------------
Top Ten 21.6%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCK)
- -----------------------------------------------------------------------------------------
SEPTEMBER 30, 1996 SEPTEMBER 30, 1997
-------------------------------------------------------------
EQUITY INCOME EQUITY INCOME S&P 500
-------------------------------------------------------------
<S> <C> <C> <C>
Auto & Transportation...... 1.2% 3.1% 3.6%
Consumer Discretionary..... 5.5 7.7 9.6
Consumer Staples........... 8.8 8.1 10.8
Financial Services......... 20.4 18.9 16.8
Health Care................ 13.4 10.3 10.7
Integrated Oils............ 14.7 15.0 7.8
Materials & Processing..... 6.1 6.9 6.8
Other Energy............... 0.3 0.1 1.5
Producer Durables.......... 1.8 1.8 4.6
Technology................. 1.6 0.7 13.2
Utilities.................. 23.1 24.5 9.2
Other...................... 3.1 2.9 5.4
- -----------------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 11
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a portfolio with a
beta of 1.20 would have seen its share price rise or fall by 12% when the
overall market rose or fell by 10%.
CASH RESERVES. The percentage of a portfolio's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing investments.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a portfolio.
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
FOREIGN HOLDINGS. The percentage of a portfolio's net assets represented by
stocks or American Depository Receipts of companies based outside the United
States.
INVESTMENT FOCUS. This grid indicates the focus of a portfolio in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. The midpoint of market capitalization (market price x shares
outstanding) of the stocks in a portfolio. Half the stocks in the portfolio
have higher market capitalizations and half lower.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
holds, the more diversified it is and the more likely to perform in line with
the overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a portfolio, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a portfolio, the weighted average P/E of the
stocks it holds. P/E is an indicator of market expectations about corporate
prospects; the higher the P/E, the greater the expectations for a company's
future growth.
R-SQUARED. A measure of how much of a portfolio's past returns can be explained
by the returns from the overall market (or its benchmark index). If a
portfolio's total return were precisely synchronized with the overall market's
return, its R-squared would be 1.00. If a portfolio's returns bore no
relationship to the market's returns, its R-squared would be 0.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a portfolio, the weighted average return
on equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a portfolio's common stocks that
come from each of the major industry groups that compose the stock market.
TEN LARGEST STOCKS. The percentage of net assets that a portfolio has invested
in its ten largest holdings. (The average for stock mutual funds is about 30%).
As this percentage rises, a portfolio's returns are likely to be more volatile,
since its return is more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the past year.
Portfolios with high turnover rates incur higher transaction costs and are more
likely to distribute capital gains (which are taxable to investors).
YIELD. A snapshot of a portfolio's income from interest and dividends. The
yield, expressed as a percentage of the portfolio's net asset value, is based
on income earned over the past 30 days and is annualized, or projected forward
for the coming year. The index yield is based on the current annualized rate of
dividends paid on stocks in the index.
9
<PAGE> 12
PERFORMANCE SUMMARY
Equity Income Fund
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Fund. Note, too, that
both share price and return can fluctuate widely so that an investment in the
Fund could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: MARCH 21, 1988 - SEPTEMBER 30, 1997
- --------------------------------------------------------------
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 30.0 4.2 34.2 40.4
- --------------------------------------------------------------
</TABLE>
See Financial Highlights table on page 16 for dividend and capital gains
information for the past five years.
CUMULATIVE PERFORMANCE: MARCH 21, 1988 - SEPTEMBER 30, 1997
- -------------------------------------------------------------------------------
[CHART]
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED SEPTEMBER 30, 1997
-------------------------------------
SINCE FINAL VALUE OF A
1 YEAR 5 YEARS INCEPTION $10,000 INVESTMENT
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Equity Income Fund 34.17% 18.20% 15.12% $38,257
Average Equity Income Fund 34.15 17.46 13.96 34,739
S&P 500 Index 40.45 20.77 17.54 46,624
- ----------------------------------------------------------------------------------------------
</TABLE>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED SEPTEMBER 30, 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 34.17% 18.20% 9.99% 5.13% 15.12%
- ----------------------------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
FINANCIAL STATEMENTS
September 30, 1997
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, preferred stocks, bonds,
etc.) and by industry sector. Other assets are added to, and liabilities are
subtracted from, the value of Total Investments to calculate the Fund's Net
Assets. Finally, Net Assets are divided by the outstanding shares of the Fund
to arrive at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table
displaying the composition of the Fund's net assets on both a dollar and
per-share basis. Because all income and any realized gains must be distributed
to shareholders each year, the bulk of net assets consists of Paid in Capital
(money invested by shareholders). The amounts shown for Undistributed Net
Investment Income and Accumulated Net Realized Gains usually approximate the
sums the Fund had available to distribute to shareholders as income dividends
or capital gains as of the statement date. Any Accumulated Net Realized Losses,
and any cumulative excess of distributions over net income or net realized
gains, will appear as negative balances. Unrealized Appreciation (Depreciation)
is the difference between the market value of the Fund's investments and their
cost, and reflects the gains (losses) that would be realized if the Fund were
to sell all of its investments at their statement-date values.
<TABLE>
<CAPTION>
MARKET
VALUE*
EQUITY INCOME FUND SHARES (000)
- -------------------------------------------------------------------------
COMMON STOCKS (91.3%)
- -------------------------------------------------------------------------
<S> <C> <C>
AUTO & TRANSPORTATION (2.8%)
Dana Corp. 36,800 $ 1,817
Federal-Mogul Corp. 41,670 1,547
Ford Motor Co. 354,900 16,059
General Motors Corp. 153,900 10,302
Genuine Parts Co. 259,250 7,988
Norfolk Southern Corp. 47,800 4,935
Union Pacific Corp. 152,200 9,532
- - US Airways Group Inc. 69,790 2,888
----------
55,068
----------
CONSUMER DISCRETIONARY (7.0%)
Avon Products, Inc. 38,700 2,399
Black & Decker Corp. 111,100 4,138
Deluxe Corp. 199,100 6,682
Eastman Kodak Co. 62,550 4,062
Fortune Brands, Inc. 677,500 22,823
IKON Office Solutions, Inc. 121,800 3,114
- - Kmart Corp. 509,200 7,129
May Department Stores Co. 278,500 15,178
The McGraw-Hill Cos. 99,200 6,715
J.C. Penney Co., Inc. 547,100 31,869
Reader's Digest Assn., Inc.
Class A 141,600 4,248
Tribune Co. 148,000 7,890
Tupperware Corp. 99,100 2,787
Wal-Mart Stores, Inc. 80,700 2,956
Waste Management Inc. 203,555 7,112
Whirlpool Corp. 99,900 6,625
- - Woolworth Corp. 31,300 693
----------
136,420
----------
CONSUMER STAPLES (7.4%)
Anheuser-Busch Cos., Inc. 319,100 14,399
The Clorox Co. 124,000 9,192
The Coca-Cola Co. 40,000 2,438
- - Gallaher Group PLC ADR 378,900 7,270
General Mills, Inc. 200,500 13,822
H.J. Heinz Co. 283,800 13,108
International Flavors &
Fragrances, Inc. 204,500 10,021
Kellogg Co. 146,600 6,176
Philip Morris Cos., Inc. 1,051,750 43,713
The Quaker Oats Co. 152,000 7,657
RJR Nabisco Holdings Corp. 120,000 4,125
UST Inc. 396,000 12,103
----------
144,024
----------
FINANCIAL SERVICES (17.3%)
American General Corp. 423,318 21,960
Banc One Corp. 372,350 20,782
Bankers Trust New York Corp. 178,500 21,866
Barnett Banks, Inc. 148,800 10,528
H & R Block, Inc. 181,900 7,026
Citicorp 25,900 3,469
CoreStates Financial Corp. 323,400 21,405
The Dun & Bradstreet Corp. 424,900 12,057
First Chicago NBD Corp. 170,500 12,830
First Union Corp. 177,000 8,861
Fleet Financial Group, Inc. 127,200 8,340
KeyCorp 146,400 9,315
Lincoln National Corp. 322,900 22,482
Marsh & McLennan Cos., Inc. 194,800 14,927
Meditrust 80,000 3,320
Mellon Bank Corp. 399,600 21,878
J.P. Morgan & Co., Inc. 204,100 23,191
National City Corp. 34,000 2,093
NationsBank Corp. 260,118 16,095
PNC Bank Corp. 332,400 16,225
</TABLE>
11
<PAGE> 14
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
MARKET
VALUE*
EQUITY INCOME FUND SHARES (000)
- -------------------------------------------------------------------------
<S> <C> <C>
SAFECO Corp. 233,600 $ 12,352
St. Paul Cos., Inc. 69,000 5,628
Sizzlers Property Investors, Inc. 57,500 665
U.S. Bancorp 89,983 8,683
Wachovia Corp. 140,600 10,123
Washington Mutual, Inc. 288,540 20,090
----------
336,191
----------
HEALTH CARE (9.4%)
Aetna Inc. 25,300 2,060
American Home Products Corp. 457,600 33,405
Baxter International, Inc. 198,600 10,377
Bristol-Myers Squibb Co. 611,700 50,618
Glaxo Wellcome PLC ADR 351,400 15,791
Eli Lilly & Co. 129,800 15,633
Merck & Co., Inc. 167,800 16,770
Pfizer, Inc. 150,300 9,027
Pharmacia & Upjohn, Inc. 814,625 29,734
----------
183,415
----------
INTEGRATED OILS (13.7%)
Amerada Hess Corp. 19,300 1,191
Amoco Corp. 275,700 26,570
Atlantic Richfield Co. 471,000 40,241
Chevron Corp. 469,800 39,081
Exxon Corp. 699,200 44,792
Lyondell Petrochemical Co. 176,291 4,617
Mobil Corp. 424,900 31,443
Phillips Petroleum Co. 125,800 6,494
Royal Dutch Petroleum Co. ADR 296,600 16,461
Texaco Inc. 687,800 42,257
USX-Marathon Group 259,000 9,631
Unocal Corp. 72,500 3,136
----------
265,914
----------
OTHER ENERGY (0.1%)
- - Oryx Energy Co. 90,200 2,294
----------
MATERIALS & PROCESSING (6.3%)
ARCO Chemical Co. 123,700 5,628
Allegheny Teledyne Inc. 275,200 7,878
BetzDearborn, Inc. 21,700 1,484
Consolidated Papers, Inc. 4,500 250
Corning, Inc. 92,200 4,356
Crown Cork & Seal Co., Inc. 87,500 4,036
Dow Chemical Co. 330,600 29,981
E.I. du Pont de Nemours & Co. 173,200 10,663
Eastman Chemical Co. 86,400 5,357
International Paper Co. 97,200 5,352
Lubrizol Corp. 66,600 2,797
Monsanto Co. 125,200 4,883
- - Owens-Illinois, Inc. 61,700 2,094
Potlatch Corp. 163,600 8,231
Solutia Inc. 12,100 242
Union Camp Corp. 174,800 10,783
Weyerhaeuser Co. 270,000 16,031
Witco Chemical Corp. 72,900 3,326
----------
123,372
----------
PRODUCER DURABLES (1.7%)
Emerson Electric Co. 115,400 6,650
Honeywell, Inc. 60,200 4,045
Lockheed Martin Corp. 78,500 8,370
Pitney Bowes, Inc. 84,300 7,013
Thomas & Betts Corp. 117,200 6,402
----------
32,480
----------
TECHNOLOGY (0.7%)
Electronic Data Systems Corp. 132,178 4,692
General Motors Corp. Class H 87,900 5,812
International Business
Machines Corp. 24,300 2,574
----------
13,078
----------
UTILITIES (22.3%)
AT&T Corp. 664,800 29,459
Allegheny Energy, Inc. 463,700 14,027
Ameritech Corp. 352,500 23,441
Baltimore Gas & Electric Co. 422,500 11,724
Bell Atlantic Corp. 724,886 58,308
BellSouth Corp. 350,600 16,215
Central & South West Corp. 421,600 9,354
Consolidated Edison Co. of
New York, Inc. 130,700 4,444
Consolidated Natural Gas Co. 334,800 19,481
Dominion Resources, Inc. 148,300 5,617
Duke Energy Corp. 304,700 15,064
Edison International 397,100 10,027
Energy Group PLC ADR 20,350 847
FPL Group, Inc. 86,200 4,418
Florida Progress Corp. 83,800 2,765
GTE Corp. 748,500 33,963
Long Island Lighting Co. 368,700 9,448
New Century Energies, Inc. 71,100 2,955
NICOR, Inc. 249,000 9,337
Northern States Power Co. 98,900 4,920
OGE Energy Corp. 181,300 8,555
PP&L Resources Inc. 234,000 5,119
Pacific Enterprises 102,300 3,465
PacifiCorp 517,000 11,568
Potomac Electric Power Co. 196,400 4,468
Public Service Enterprise
Group Inc. 176,600 4,547
SBC Communications Inc. 317,701 19,499
SCANA Corp. 190,600 4,777
Southern Co. 411,100 9,275
Southern New England
Telecommunications Corp. 99,800 4,085
TECO Energy, Inc. 214,900 5,265
Texas Utilities Co. 258,500 9,306
Union Electric Co. 285,700 10,981
U S WEST Communications
Group 804,550 30,975
- - U S WEST Media Group 150,000 3,347
Western Resources, Inc. 64,000 2,196
Wisconsin Energy Corp. 447,100 11,625
----------
434,867
----------
OTHER (2.6%)
Cooper Industries, Inc. 35,000 1,892
Federal Signal Corp. 56,000 1,421
General Electric Co. 216,200 14,715
Minnesota Mining &
Manufacturing Co. 229,300 21,210
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- -------------------------------------------------------------------------
<S> <C> <C>
Ogden Corp. 323,900 $ 7,652
Westinghouse Electric Corp. 141,600 3,832
----------
50,722
----------
- -------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost $1,132,542) 1,777,845
- -------------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (1.8%)
- -------------------------------------------------------------------------
Aetna Inc.
6.25% Cvt. Pfd. Series C 27,000 2,092
AirTouch Communications, Inc.
6.00% Cvt. Pfd. 140,000 4,515
Crown Cork & Seal Co., Inc.
4.50% Cvt. Pfd. 140,000 6,160
Globalstar Telecommunications
Ltd. 6.50% Cvt. Pfd. 76,100 6,773
Host Marriott Corp.
6.75% Cvt. Pfd. 75,000 5,091
Houston Industries Inc.
7.00% Cvt. Pfd. 75,000 3,872
Loral Space & Communications
Ltd. 6.00% Cvt. Pfd. Series C 90,000 5,344
McDermott International, Inc.
$2.875 Cvt. Pfd. Series C 17,500 979
- -------------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(COST $28,184) 34,826
- -------------------------------------------------------------------------
<CAPTION>
FACE
AMOUNT
(000)
- -------------------------------------------------------------------------
CONVERTIBLE BONDS (0.7%)
- -------------------------------------------------------------------------
<S> <C> <C>
ALZA Corp.
0.00%, 7/14/14 $ 8,784 3,876
Molten Metal Technology Inc.
5.50%, 5/1/06 1,550 651
National Semiconductor
6.50%, 10/1/02 6,000 6,937
Roche Holdings, Inc.
0.00%, 4/20/10 800 403
0.00%, 5/6/12 2,500 1,091
Time Warner, Inc.
0.00%, 12/17/12 2,600 1,017
- -------------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(COST $14,433) 13,975
- -------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (6.3%)
- -------------------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
6.05%, 10/1/97
(COST $122,688) 122,688 122,688
- -------------------------------------------------------------------------
TOTAL INVESTMENTS (100.1%)
(COST $1,297,847) 1,949,334
- -------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
MARKET
VALUE*
(000)
- -------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.1%)
- -------------------------------------------------------------------------
<S> <C>
Other Assets--Note C $ 8,343
Liabilities (9,667)
------------
(1,324)
- -------------------------------------------------------------------------
NET ASSETS (100%)
- -------------------------------------------------------------------------
Applicable to 87,449,978 outstanding
$.001 par value shares
(authorized 1,000,000,000 shares) $1,948,010
=========================================================================
NET ASSET VALUE PER SHARE $22.28
=========================================================================
</TABLE>
*See Note A in Notes to Financial Statements.
- -Non-Income Producing Security.
ADR--American Depository Receipt.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
AT SEPTEMBER 30, 1997, NET ASSETS CONSISTED OF:
- ---------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ---------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $1,201,063 $13.74
Undistributed Net
Investment Income 15,636 .18
Accumulated Net
Realized Gains 79,824 .91
Unrealized Appreciation--
Note E 651,487 7.45
- ---------------------------------------------------------------------
NET ASSETS $1,948,010 $22.28
=====================================================================
</TABLE>
13
<PAGE> 16
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
YEAR ENDED SEPTEMBER 30, 1997
(000)
- --------------------------------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 52,318
Interest 6,653
-----------
Total Income 58,971
-----------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 2,739
Performance Adjustment (287)
The Vanguard Group--Note C
Management and Administrative 4,112
Marketing and Distribution 311
Taxes (other than income taxes) 115
Custodian Fees 40
Auditing Fees 15
Shareholders' Reports 64
Annual Meeting and Proxy Costs 8
Directors' Fees and Expenses 4
-----------
Total Expenses 7,121
Expenses Paid Indirectly--Note C (171)
-----------
Net Expenses 6,950
- --------------------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME 52,021
- --------------------------------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 87,674
- --------------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 330,068
- --------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $469,763
==============================================================================================================
</TABLE>
14
<PAGE> 17
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
YEAR ENDED SEPTEMBER 30,
-------------------------------
1997 1996
(000) (000)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 52,021 $ 43,060
Realized Net Gain 87,674 37,039
Change in Unrealized Appreciation (Depreciation) 330,068 107,851
--------------------------------
Net Increase in Net Assets Resulting from Operations 469,763 187,950
--------------------------------
DISTRIBUTIONS
Net Investment Income (51,653) (41,545)
Realized Capital Gain (43,397) (10,870)
--------------------------------
Total Distributions (95,050) (52,415)
--------------------------------
NET EQUALIZATION CREDITS--Note A 2,336 2,104
--------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 438,790 390,890
Issued in Lieu of Cash Distributions 85,052 46,196
Redeemed (262,262) (232,739)
--------------------------------
Net Increase from Capital Share Transactions 261,580 204,347
- ------------------------------------------------------------------------------------------------------------------------
Total Increase 638,629 341,986
- ------------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 1,309,381 967,395
--------------------------------
End of Year $1,948,010 $1,309,381
========================================================================================================================
(1)Shares Issued (Redeemed)
Issued 22,366 23,377
Issued in Lieu of Cash Distributions 4,493 2,725
Redeemed (13,431) (13,877)
--------------------------------
Net Increase in Shares Outstanding 13,428 12,225
========================================================================================================================
</TABLE>
15
<PAGE> 18
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 THROUGHOUT EACH YEAR 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $17.69 $15.65 $13.16 $14.62 $12.81
- ---------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .64 .63 .60 .59 .59
Net Realized and Unrealized Gain (Loss) on Investments 5.17 2.18 2.56 (.92) 1.81
-------------------------------------------------------------
Total from Investment Operations 5.81 2.81 3.16 (.33) 2.40
-------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.64) (.60) (.58) (.61) (.59)
Distributions from Realized Capital Gains (.58) (.17) (.09) (.52) --
-------------------------------------------------------------
Total Distributions (1.22) (.77) (.67) (1.13) (.59)
- ---------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $22.28 $17.69 $15.65 $13.16 $14.62
===========================================================================================================================
TOTAL RETURN 34.17% 18.22% 24.77% -2.19% 19.17%
===========================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $1,948 $1,309 $967 $901 $1,106
Ratio of Total Expenses to Average Net Assets 0.45% 0.42% 0.47% 0.43% 0.40%
Ratio of Net Investment Income to Average Net Assets 3.25% 3.69% 4.27% 4.41% 4.39%
Portfolio Turnover Rate 22% 21% 31% 18% 15%
Average Commission Rate Paid $.0599 $.0598 N/A N/A N/A
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE> 19
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. Newell Associates; Spare, Kaplan, Bischel & Associates; and John A. Levin
& Co., Inc., provide investment advisory services to the Fund for fees
calculated at an annual percentage rate of average net assets. The basic fee of
Spare, Kaplan, Bischel & Associates is subject to quarterly adjustments based
on performance relative to the S&P/BARRA Value Index; the basic fee for John A.
Levin & Co., Inc., is subject to quarterly adjustments based on performance
relative to the S&P 500 Index. For the year ended September 30, 1997, the
aggregate advisory fee represented an effective annual basic rate of 0.17% of
the Fund's average net assets before a decrease of $287,000 (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 September 30,
1997, the Fund had contributed capital of $130,000 to Vanguard (included in
Other Assets), representing 0.6% 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
year ended September 30, 1997, these arrangements reduced the Fund's expenses
by $171,000 (0.01% of average net assets).
17
<PAGE> 20
D. During the year ended September 30, 1997, the Fund purchased $511,328,000 of
investment securities and sold $321,422,000 of investment securities other than
temporary cash investments.
E. At September 30, 1997, net unrealized appreciation of investment
securities for financial reporting and federal income tax purposes was
$651,487,000, consisting of unrealized gains of $657,494,000 on securities that
had risen in value since their purchase and $6,007,000 in unrealized losses on
securities that had fallen in value since their purchase.
18
<PAGE> 21
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Directors of
Vanguard Equity Income 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 Equity Income Fund (the "Fund") at September 30, 1997, the results of
its operations for the year then ended, the changes in its net assets for each
of the two years in the period then ended and the financial highlights for each
of the five years in the period then ended, in conformity with generally
accepted accounting principles. These financial statements and financial
highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits, which included confirmation of securities at September 30, 1997 by
correspondence with the custodian and the application of alternative auditing
procedures where securities purchased had not been settled, provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
October 31, 1997
19
<PAGE> 22
SPECIAL 1997 TAX INFORMATION (UNAUDITED) FOR VANGUARD EQUITY INCOME FUND
This information for the fiscal year ended September 30, 1997, is included
pursuant to provisions of the Internal Revenue Code.
The Fund designates $74,663,000 as capital gain dividends (from net
long-term capital gains), of which $8,824,000 was distributed to shareholders in
December 1996. The balance of $65,839,000, along with any additional gains
realized through October 31, 1997, will be distributed in December 1997.
For corporate shareholders, 78.9% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
20
<PAGE> 23
DIRECTORS AND OFFICERS
JOHN C. BOGLE
Chairman of the Board and Director of The Vanguard Group, Inc., and of each of
the investment companies in The Vanguard Group.
JOHN J. BRENNAN
President, Chief Executive Officer, and Director of The Vanguard Group, Inc.,
and of each of the investment companies in The Vanguard Group.
ROBERT E. CAWTHORN
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Managing Director
of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun
Company, Inc., and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions,
Inc., Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance
Co., and Ladies Professional Golf Association; Trustee Emerita of Wellesley
College.
BRUCE K. MACLAURY
President Emeritus of The Brookings Institution; Director of American Express
Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co., and
NACCO Industries.
JAMES O. WELCH, JR.
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON
Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins
Engine Co., and The Mead Corp.; Trustee of Vanderbilt University.>> 2
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND
Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the
investment companies in The Vanguard Group.
KAREN E. WEST
Controller; Principal of The Vanguard Group, Inc.; Controller of each of the
investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DISTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MACKINNON
Managing Director, Fixed Income Group.
F. WILLIAM MCNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"Standard & Poor's 500," "S&P 500(R)," "Standard & Poor's(R)," "S&P(R)," and
"500" are trademarks of The McGraw-Hill Companies, Inc. Frank Russell Company
is the owner of trademarks and copyrights relating to the Russell Indexes.
"Wilshire 4500" and "Wilshire 5000" are trademarks of Wilshire Associates.
<PAGE> 24
THE VANGUARD
FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Growth and Income Portfolio
Vanguard Selected Value Portfolio
Vanguard/Trustees' Equity-U.S. Portfolio
Vanguard Convertible Securities Fund
BALANCED FUNDS
Vanguard/Wellington Fund
Vanguard/Wellesley Income Fund
Vanguard STAR Portfolio
Vanguard Asset Allocation Fund
Vanguard LifeStrategy Portfolios
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
Vanguard Horizon Fund
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard International Value Portfolio
INDEX FUNDS
Vanguard Index Trust
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Vanguard International Equity Index Fund
Vanguard Total International Portfolio
FIXED-INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Money Market Reserves
Vanguard Treasury Money Market Portfolio
Vanguard Admiral Funds
INCOME FUNDS
Vanguard Fixed Income Securities Fund
Vanguard Admiral Funds
Vanguard Preferred Stock Fund
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds (CA, NJ, NY, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds (CA, FL, NJ, NY, OH, PA)
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 you invest or send money. Prospectuses can
be obtained directly from The Vanguard Group.
[THE VANGUARD GROUP LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482
Q650-9/97 - (C) 1997 Vanguard Marketing Corporation, Distributor
