-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, I1GzYnXZv7ZrKTaVl3OKfX8qggZDmZ0V9Eny7HzZZW8+5v2KuBY708Q9qSEdzzgn S1WaL3UhVn5Bsdv1NLGVJg== 0000893220-99-000190.txt : 19990222 0000893220-99-000190.hdr.sgml : 19990222 ACCESSION NUMBER: 0000893220-99-000190 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990219 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VANGUARD/PRIMECAP FUND INC CENTRAL INDEX KEY: 0000752177 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 232311358 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: N-30D SEC ACT: SEC FILE NUMBER: 811-04098 FILM NUMBER: 99545639 BUSINESS ADDRESS: STREET 1: PO BOX 2600 VM #V34 CITY: VALLEY FORGE STATE: PA ZIP: 19482 BUSINESS PHONE: 6106696289 FORMER COMPANY: FORMER CONFORMED NAME: PRIMECAP FUND INC DATE OF NAME CHANGE: 19920703 N-30D 1 ANNUAL REPORT - VANGUARD PRIMECAP FUND 1 VANGUARD PRIMECAP FUND [PHOTO] ANNUAL REPORT DECEMBER 31, 1998 [THE VANGUARD GROUP LOGO] 2 AT VANGUARD, WE BELIEVE THAT TRADITION MATTERS Our 8,000 crew members embrace the traditional values on which our success is built, including integrity, hard work, thrift, teamwork, and fair dealing on behalf of our clients. This year, our report cover pays homage to three anniversaries, each of great significance to The Vanguard Group: - - The 200th anniversary of the Battle of the Nile, which commenced on August 1, 1798. HMS Vanguard, the victorious British flagship at the Nile, is our namesake. And its motto--"Leading the way"--serves as a guiding principle for our company. - - The 100th birthday, on July 23, of Walter L. Morgan, founder of Wellington Fund, the oldest member of what became The Vanguard Group. Mr. Morgan was friend and mentor to Vanguard founder John C. Bogle, and helped to shape the standards and business principles that Mr. Bogle laid down for Vanguard at its beginning nearly 25 years ago: a stress on balanced, diversified investments; insistence on fair dealing and candor with clients; and a focus on long-term investing. To our great regret, Mr. Morgan died on September 2. - - The 70th anniversary, on December 28, of the incorporation of Vanguard Wellington Fund. It is the nation's oldest balanced mutual fund, and one of only a handful of funds created in the 1920s that are still in operation. Although Vanguard constantly tackles new challenges, adopts new technology, and develops new services, we treasure the traditions and values that set us apart in a crowded, competitive industry. And we salute our shareholders, whose support and trust we strive to earn each and every day. [PHOTO] CONTENTS A MESSAGE TO OUR SHAREHOLDERS 1 THE MARKETS IN PERSPECTIVE 4 REPORT FROM THE ADVISER 6 FUND PROFILE 8 PERFORMANCE SUMMARY 10 FINANCIAL STATEMENTS 11 REPORT OF INDEPENDENT ACCOUNTANTS 17 All comparative mutual fund data are from Lipper or Morningstar, unless otherwise noted. 3 FELLOW SHAREHOLDER, [PHOTO] [PHOTO] JOHN J. BRENNAN JOHN C. BOGLE CHAIRMAN & CEO SENIOR CHAIRMAN Vanguard PRIMECAP Fund earned +25.4% during 1998, a year when the stock market encountered considerable turbulence en route to yet another strong performance. For the year, our return was comfortably ahead of that achieved by the average growth mutual fund. However, we fell short of our index benchmark during a year when a relative handful of funds (only 17% of general equity funds) matched the remarkable performance of the unmanaged Standard & Poor's 500 Composite Stock Price Index.
- ------------------------------------------------- TOTAL RETURNS YEAR ENDED DECEMBER 31, 1998 - ------------------------------------------------- Vanguard PRIMECAP Fund +25.4% - ------------------------------------------------- Average Growth Fund +22.9% - ------------------------------------------------- S&P 500 Index +28.6% - -------------------------------------------------
The table at right presents the 1998 total returns (capital change plus reinvested dividends) of PRIMECAP, our average peer, and the S&P 500 Index. The fund's return is based on an increase in net asset value from $39.56 per share on December 31, 1997, to $47.66 per share on December 31, 1998, adjusted for dividends totaling $0.35 per share paid from net investment income and distributions totaling $1.52 per share paid from net realized capital gains. FINANCIAL MARKETS IN REVIEW The U.S. economy grew at a robust pace--more than 3%--during 1998 as it shrugged off the effects of serious financial problems in Asia, Russia, and Latin America. Troubles abroad slowed demand for American exports and boosted demand for imported goods, widening the U.S. trade deficit. But the domestic economy got a powerful push from higher consumer spending, which was encouraged by low unemployment (4.3% at year-end) and higher wages (up about 4%, well above the 1.6% inflation rate). The optimism that kept shopping malls and automobile showrooms busy was also a factor in the financial markets. Stock prices shot up during the first half of the year, although corporate earnings dipped slightly, and by July 17 the S&P 500 Index had gained +23.3%. But fears that Asia's financial troubles were spreading worldwide touched off a sharp decline: Over the next six weeks, the S&P 500 Index fell -19.2%. Declines were even steeper for smaller stocks: The Russell 2000 Index of small-capitalization stocks fell nearly -40% from its mid-April peak to its low in October. The stock market then revived with remarkable speed and vigor. By year-end, the S&P 500 Index was again in record territory, having gained +28.6% for the year. This result, however, masked weakness elsewhere in the market. The Wilshire 4500 Equity Index, which comprises all U.S. common stocks not included in the S&P 500, gained just +8.6%, while the Russell 2000 Index declined -2.5%. In all, more stocks declined in price than rose. Among large-cap stocks, there was a huge gap between returns on growth and value stocks: The S&P 500's growth component gained +42.2% during the year, nearly three times the +14.7% return on its value stocks. Interest rates declined on balance during 1998. Bond prices, which move in the opposite direction from rates, generally rose. Price appreciation accounted for 2 percentage 1 4 points of the +8.7% total return of the Lehman Brothers Aggregate Bond Index. Rates fell furthest--roughly 1 percentage point--for U.S. Treasury securities, which benefited from a "flight to quality" as many investors shunned riskier securities. 1998 PERFORMANCE OVERVIEW A particularly strong second-half performance led PRIMECAP Fund to a +25.4% return in 1998, outpacing the return of the average growth fund by 2.5 percentage points. However, we fell 3.2 percentage points behind the +28.6% return of the S&P 500 Index. Our margin over competitors was due largely to the stock selections of our adviser, PRIMECAP Management Company. PRIMECAP Management's disciplined approach to choosing stocks often leads to a portfolio that differs considerably in industry weightings from those of other funds or of the S&P 500 Index. For example, during the year we held five times the index weighting in transportation stocks (about 17% versus 3%), double the index weighting in technology issues (29% versus 13%), while holding no stocks from the utilities and integrated oils sectors, which account for about 11% and 7%, respectively, of the S&P 500 Index. Such differences are why our returns often differ from these benchmarks. While our first-half return trailed that of both the average growth fund (by 3.2 percentage points) and the S&P 500 (by 5.8 percentage points), during the latter half of the year we solidly outpaced both our average peer and the index. We fell short of the index for the year for two main reasons: the wide split between large-cap and small-cap stock returns and the fund's sizable cash holdings. The 50 largest stocks in the S&P 500, representing 55% of the index's market value, gained more than 40% in 1998, while the U.S. stock market as a whole gained +23.4%. Having only about 13% of PRIMECAP Fund's assets in the 50 behemoth stocks proved to be a disadvantage in a "bigger is better" year. Our worst-performing group in comparison with the index was auto & transportation stocks, principally airline issues. This group earned only about +5% for the fund, versus +22% for the transportation stocks in the index. On the other hand, our performance was aided by a large stake in technology stocks, which accounted for about 29% of assets during the year, more than twice the index weighting. Our stocks in this sector, although earning more than +57% for the year, trailed the average +83% gain of the index's tech stocks, led by Microsoft (+115%), Intel (+69%), IBM (+77%), and Cisco Systems (+150%)--four of the ten largest stocks in the index. For much of the year, PRIMECAP Fund's cash holdings exceeded 10% of its assets, although by year-end cash was down to about 6% of assets. In such a powerful stock market as we experienced during 1998, cash retards a fund's return.
- --------------------------------------------------------------------- TOTAL RETURNS 10 YEARS ENDED DECEMBER 31, 1998 ----------------------------------------- AVERAGE FINAL VALUE OF ANNUAL A $10,000 RATE INITIAL INVESTMENT - --------------------------------------------------------------------- Vanguard PRIMECAP Fund +20.0% $62,048 - --------------------------------------------------------------------- Average Growth Fund +16.3% $45,189 - --------------------------------------------------------------------- S&P 500 Index +19.2% $57,963 - ---------------------------------------------------------------------
LONG-TERM PERFORMANCE OVERVIEW Vanguard PRIMECAP Fund's long-term record is, in a word, admirable. Our return over the past decade exceeded that of both our average peer and the S&P 500 Index, as shown in the table at left. The table presents the average annual return for the past ten years for PRIMECAP, the average growth fund, and the index, and shows 2 5 the ending value of hypothetical $10,000 investments in each, assuming that income dividends and capital gains distributions had been reinvested. Our extra return of 3.7 percentage points versus the average growth fund had an astounding long-term impact: A $10,000 investment in PRIMECAP Fund would have grown to $62,048, or $16,859 more than the final value of a $10,000 investment in the average growth fund. That is a difference of more than 11/2 times the initial $10,000 investment. Even our seemingly modest edge of 0.8 percentage point annually versus the S&P 500 Index amounted to a significant sum of $4,085 when compounded over a decade. We salute PRIMECAP Management for its superb job of selecting the fund's investments during the decade. Our low operating costs also played a role in our strong performance relative to other funds. PRIMECAP Fund's expense ratio (operating expenses as a percentage of average net assets) was 0.51% in 1998, a full percentage point below the 1.53% expense ratio charged by the average growth fund. This cost advantage of one percentage point annually gives the fund a nice tailwind, and our adviser has made the most of this edge. While we're proud of our long-term record, we offer two caveats. First, it was achieved during a period that was among the most favorable ever for the U.S. stock market in general and for growth stocks in particular. Our average return of +20% per year over the past decade is roughly double the long-term return from common stocks. Over the past four years, the S&P 500 Index gained an average of +30.5% annually--a record second only to 1933-1936, when the market and the nation were rising from the abyss of the Great Depression. It's hard to imagine such a pace continuing. On the other hand, if inflation stays dormant, large gains aren't necessary to earn strong real, or inflation-adjusted, returns. The second caveat is that PRIMECAP's performance, while stellar over the long haul, has had its short-term disappointments. Our return surpassed that of the S&P 500 Index in six of the past ten years, but trailed in four of those years, including 1998. We encourage our fellow shareholders to maintain a long-term focus when evaluating the fund. IN SUMMARY The past year demonstrated both the impressive rewards that the stock market can provide and the sharp downturns that can sweep the market. Indeed, even greater volatility--up and down--comes with the territory when investing in growth stocks. To help weather such volatility--and as a hedge against the possibility that stocks won't be the best-performing asset class over any particular future period--we recommend a balanced approach to investing. Select a mix of stock funds, bond funds, and money market funds in proportions suited to your own investment time horizon, financial situation, and tolerance for market fluctuations. Once you've made such a plan, stick with it through the markets' ups and downs. Vanguard PRIMECAP Fund will "stay the course" by continuing to seek out stocks with strong long-term growth potential selling at reasonable prices. /s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN John C. Bogle John J. Brennan Senior Chairman Chairman and Chief Executive Officer January 14, 1999 3 6 THE MARKETS IN PERSPECTIVE YEAR ENDED DECEMBER 31, 1998 [PHOTO] Financial markets continued to produce solid overall gains during 1998. After overcoming a sharp, six-week setback in July and August, the S&P 500 Index gained 28.6% for the year, marking the first time the index had produced returns of 20% or more in four consecutive years. Bond prices rose as interest rates generally declined over the year. Returns from overseas stock markets varied widely, with big gains in Europe, small gains in the Pacific, and losses in most emerging markets. U.S. STOCK MARKETS Large-capitalization stocks--especially those of large growth companies--were the best performers during 1998. The 50 largest stocks within the S&P 500 Index earned more than 40%, while the return of the other 450 stocks was less than 17%. The stock market as a whole, as measured by the Wilshire 5000 Equity Index, earned 23.4%. Small-cap stocks, represented by the Russell 2000 Index, declined 2.5% for the year. The huge gap between returns of large and small stocks was not the only oddity during the year. Among large stocks there also was a large disparity in performance between growth and value stocks. Within the S&P 500 Index, growth stocks rose 42.2%, while value stocks were up 14.7%. The gap of 27.5 percentage points is the largest in the 23 years that the growth and value components have been tracked.
- ------------------------------------------------------------------------------ AVERAGE ANNUALIZED RETURNS PERIODS ENDED DECEMBER 31, 1998 -------------------------------------- 1 YEAR 3 YEARS 5 YEARS - ------------------------------------------------------------------------------ STOCKS S&P 500 Index 28.6% 28.2% 24.1% Russell 2000 Index -2.5 11.6 11.9 MSCI EAFE Index 20.3 9.3 9.5 - ------------------------------------------------------------------------------ BONDS Lehman Aggregate Bond Index 8.7% 7.3% 7.3% Lehman 10 Year Municipal Bond Index 6.8 6.8 6.4 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 5.1 5.2 5.1 - ------------------------------------------------------------------------------ OTHER Consumer Price Index 1.6% 2.2% 2.4% - ------------------------------------------------------------------------------
Stocks rose strongly during the first half of the year. But after hitting a then-record high on July 17, the S&P 500 Index fell by 19.2% during the following six weeks. Declines were steeper for most smaller stocks. The Russell 2000 Index fell nearly 40% from its peak in April before climbing back during the fourth quarter. The summer slump in stock prices reflected several factors that raised anxiety among investors and prompted a reconsideration of risk that extended past stocks to bonds. Among these factors were deteriorating corporate earnings; Russia's default on its debts; sharp swings in currency exchange rates; and lingering economic weakness in Asia. Although these sources of uncertainty remained as the year went on, many investors reacted not by abandoning stocks, but by selecting large, well-known stocks they perceived as reliable vehicles for long-term growth. The strong rebound in prices during the fourth quarter was due in large part to the calming influence on jittery markets of the Federal Reserve Board's decision to cut short-term interest rates by 0.75 percentage point. 4 7 Technology stocks led the market's advance during 1998, rising 83%. Investors were attracted by rapid revenue growth and a belief that consumers and businesses will keep spending freely on computers, software, and computer services. Speculation also played a role in the surge. Burgeoning activity on the Internet sent many stocks, even those with no hint of profitability, skyrocketing. The bulge in Internet stock prices prompted comparisons with such historic asset "bubbles" as Japan's stock market in the late 1980s and the tulip-bulb mania in Holland in the 1630s. Health care and utilities, especially telecommunications providers, also soared, achieving returns of more than 43%. Both sectors benefited from rising demand for their products and a perception that they are somewhat protected from foreign economic troubles and foreign competition. Consumer-related stocks such as retailers also did well, reflecting strength in consumer spending. Americans spent almost every after-tax dollar they earned during 1998. Jobs were abundant; unemployment fell to 4.3% by year-end. The worst-performing groups were two directly harmed by falling commodity prices: oil drilling and services firms in the "other energy" category (-36%) and materials & processing firms (-1%), such as paper, steel, and chemical makers. Producer-durables companies, such as machinery and aircraft makers, eked out a 2% return as companies saw falling sales abroad and rising competition at home from foreign firms. U.S. BOND MARKETS The fall in interest rates during 1998 was steepest for U.S. Treasury securities, which benefited from heightened aversion to risk among investors and from a slight decrease in supply, thanks to a $70 billion Federal Budget surplus. The low inflation rate--consumer prices were up just 1.6%--gave the Federal Reserve the flexibility to cut short-term rates even though economic growth was strong. Yields on long-term Treasury issues fell by roughly 1 percentage point, and the 30-year Treasury bond's yield was 5.09% on December 31. Lower rates mean higher bond prices, and the Lehman Brothers Long U.S. Treasury Index earned a total return of 13.5%, an astounding margin of nearly 12 percentage points over the inflation rate. Bonds lacking the unquestioned credit quality of Treasuries did not fare as well, reflecting a repricing of risk and a "flight to quality" by investors who began to feel they had been underestimating risk. One result was price declines that nearly offset the interest earned on high-yield "junk" bonds. However, high-quality corporate bonds and mortgage-backed securities generally held up well. The Lehman Aggregate Bond Index, which encompasses Treasury, mortgage, and high-quality corporate securities and has an intermediate-term average maturity, earned a solid 8.7%. Yields on long-term municipal bonds declined only slightly during the year, and by December 31 were only a tad lower than yields on long-term Treasuries. This was striking because the interest on municipals is exempt from federal income tax. INTERNATIONAL STOCK MARKETS Europe's stock markets beat even the S&P 500 Index's gaudy return, gaining 28.7% in U.S.-dollar terms, with about 5% of the gain due to a fall in the dollar versus most European currencies. Pacific-region stocks rose 2.6%, although it took a fall in the dollar's value versus the Japanese yen to overcome losses in local-currency terms. Overall, developed international markets, as measured by the MSCI EAFE Index, earned 20.3%. Investors' confidence in emerging markets continued to evaporate in 1998, and stocks in these markets fell about 25% as a group. The few bright spots included South Korea (+141%) and the Philippines (+13%), which had suffered big declines in 1997. 5 8 REPORT FROM THE ADVISER [PHOTO] During 1998, Vanguard PRIMECAP Fund's total return of 25.4% trailed the 28.6% return recorded by the unmanaged S&P 500 Index, but exceeded the 22.9% return achieved by the average growth mutual fund. Throughout the first three quarters of the year, apprehension mounted over the turmoil in Southeast Asia, deterioration in the economies of Latin America, and the near-collapse of the Russian economy. Investors sought safety in the very largest-capitalization stocks, perceiving that these companies could manage to consistently increase earnings despite the difficult global environment. Consequently, PRIMECAP Fund--holding less than 13% of assets in very large stocks versus 55% for the S&P 500 Index--underperformed the index in each of the first three quarters. Through September 30, the fund was down 2.6% versus a 6.0% gain for the S&P 500. During the fourth quarter, signs of improving conditions in Asia, complemented by continued strength in the domestic economy, regenerated confidence among investors. A major rally ensued--one that was not limited to the largest-capitalization issues. PRIMECAP Fund appreciated 28.8% in the fourth quarter, well ahead of the 21.3% gain for the S&P 500 Index. We view the fourth quarter as somewhat of a seminal period, and hope that it marks a turning point in market leadership. In the fund's semiannual report, we discussed extensively how performance had been concentrated in the very largest stocks. However, as investors' confidence grew in the fourth quarter, they ventured outside the universe of large stocks. It was the first quarter in a long time that saw smaller stocks nearly keeping pace with the market averages. During the final three months of the year, the average small-cap stock fund appreciated 19.4% versus 21.3% for the S&P 500 Index. However, for the full year the average stock woefully underperformed the S&P 500. In fact, although the S&P 500 Index gained 28.6% for the year, declining issues outnumbered those that advanced in price on the New York Stock Exchange. On the Nasdaq, stocks whose prices declined outnumbered those that registered gains by a margin of nearly two to one. Looking at the year in its entirety, PRIMECAP Fund's performance was hampered by two factors: our substantial commitment to airline stocks and our cash position. The performance of the airline stocks has been particularly frustrating for us because operationally the companies have performed superbly. Industry profitability hit historic highs during 1998. The outlook for traffic and fuel costs (a major cost of doing business) remains favorable, and the industry has exercised restraint in adding capacity. Despite the positive current results and outlook, the stocks performed miserably in 1998. As a group, our transportation holdings appreciated a mere 5.2% for the year. This includes a 46.1% gain in FDX (parent company of Federal Express). We believe Federal Express, the premier provider of overnight package 6 9 delivery, will enjoy accelerating growth as the preferred fulfillment option for burgeoning Internet commerce. We also expect the market to award to FDX a higher price/earnings multiple, reflecting the company's accelerating growth rate and its association with the Internet. We concluded our 1997 report on a cautious note, explaining that we had increased the fund's cash position to an unusually high 13% of assets. Although we have reduced the cash position throughout the year (to 6.2% of assets as of December 31), the cash holdings certainly hurt the fund's results. On a more encouraging note, our substantial holdings in technology stocks appreciated 57.5% for the year (44.4% in the fourth quarter alone). In our semiannual report, we argued that the then-current earnings disappointments among technology companies were primarily a function of an inventory liquidation phenomenon. The sensational success of Dell Computer's "build to order" business model forced others in the industry to embrace a similar strategy. This triggered a chain reaction of inventory reduction that affected all suppliers, but was particularly severe for semiconductor manufacturers. We also discussed why we believed that the inventory liquidation had nearly run its course. In retrospect, our analysis seems to have proved correct. PRIMECAP Fund enjoyed explosive gains in our four largest semiconductor holdings during the second half of the year: Texas Instruments, Micron Technology, Intel, and Xilinx posted gains of 47.2%, 103.8%, 60.1%, and 91.5%, respectively. Our holdings of communications technology stocks also added meaningfully to the fund's results. This group was paced by Nokia's 250% gain (third best of all NYSE stocks), while Ericsson and Tellabs also outpaced the S&P 500 Index's return. A third sector that made an excellent contribution to the fund's return relative to the index was health care. Following a 69% gain in 1997, our selections appreciated 52.7% in 1998. Medical device maker Guidant, the 1997 standout (it rose 119% that year), again led the group, rising 76.8%. Pharmacia & Upjohn, an out-of-favor turnaround situation, posted a 58.6% gain. Medtronic, another medical device maker, increased 42.1%. We continue to see attractive opportunities in the broader market. The valuation excesses that exist are primarily in the largest stocks. The fund maintains only a small exposure to this group of stocks. We hope the fourth quarter will indeed prove to have been a turning point, and that investors' "flight to safety" has moderated. If so, we believe that PRIMECAP Fund is positioned to achieve favorable relative returns. Howard B. Schow, Portfolio Manager Theo A. Kolokotrones, Portfolio Manager Joel P. Fried, Assistant Portfolio Manager F. Jack Liebau Jr., Assistant Portfolio Manager PRIMECAP Management Company January 11, 1999 INVESTMENT PHILOSOPHY The fund reflects a belief that superior long-term investment results can be achieved by selecting stocks with prices lower than the fundamental value of the underlying companies, based on the investment adviser's assessment of such factors as their industry positions, growth potential, and expected profitability. 7 10 FUND PROFILE PRIMECAP FUND This Profile provides a snapshot of the fund's characteristics as of December 31, 1998, compared where appropriate to an unmanaged index. Key elements of this Profile are defined on page 9.
PORTFOLIO CHARACTERISTICS - ---------------------------------------- PRIMECAP S&P 500 - ---------------------------------------- Number of Stocks 96 500 Median Market Cap $13.2B $60.3B Price/Earnings Ratio 22.0x 28.0x Price/Book Ratio 3.7x 4.9x Yield 0.5% 1.3% Return on Equity 19.3% 22.5% Earnings Growth Rate 18.2% 17.2% Foreign Holdings 6.5% 1.6% Turnover Rate 13% -- Expense Ratio 0.51% -- Cash Reserves 6.2% --
INVESTMENT FOCUS - ---------------------------------------- [GRAPH]
VOLATILITY MEASURES - ---------------------------------------- PRIMECAP S&P 500 - ---------------------------------------- R-Squared 0.82 1.00 Beta 1.04 1.00
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) - ---------------------------------------------- Texas Instruments, Inc. 5.3% Guidant Corp. 5.1 FDX Corp. 5.0 Micron Technology, Inc. 4.6 Intel Corp. 4.3 Pharmacia & Upjohn, Inc. 3.9 Delta Air Lines, Inc. 3.2 AMR Corp. 3.0 Motorola, Inc. 2.3 Compaq Computer Corp. 2.3 - ---------------------------------------------- Top Ten 39.0%
SECTOR DIVERSIFICATION (% OF COMMON STOCKS) - -------------------------------------------------------------------------------- DECEMBER 31, 1997 DECEMBER 31, 1998 ----------------------------------------------- PRIMECAP PRIMECAP S&P 500 ----------------------------------------------- Auto & Transportation 19.1% 15.8% 2.5% Consumer Discretionary 9.6 8.1 12.0 Consumer Staples 1.7 1.9 9.8 Financial Services 6.5 3.1 16.2 Health Care 12.3 14.3 12.5 Integrated Oils 0.0 0.0 5.2 Other Energy 2.1 1.1 0.9 Materials & Processing 7.9 5.1 3.7 Producer Durables 10.3 11.0 3.2 Technology 29.2 33.8 16.6 Utilities 0.4 0.0 11.7 Other 0.9 5.8 5.7 - --------------------------------------------------------------------------------
8 11 BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. CASH RESERVES. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. This figure does not include cash invested in futures contracts to simulate stock investment. EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a fund. EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. INVESTMENT FOCUS. This grid indicates the focus of a fund in terms of two attributes: market capitalization (large, medium, or small) and relative valuation (growth, value, or a blend). MEDIAN MARKET CAP. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund holds, the more diversified it is and the more likely to perform in line with the overall stock market. PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total return were precisely synchronized with the overall market's return, its R-squared would be 1.00. If a fund's returns bore no relationship to the market's returns, its R-squared would be 0. RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. SECTOR DIVERSIFICATION. The percentages of a fund's common stocks that come from each of the major industry groups that compose the stock market. TEN LARGEST HOLDINGS. The percentage of net assets that a fund has invested in its ten largest holdings. (The average for stock mutual funds is about 30%.) As this percentage rises, a fund's returns are likely to be more volatile because they are more dependent on the fortunes of a few companies. TURNOVER RATE. An indication of trading activity during the past year. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). YIELD. A snapshot of a fund's income from interest and dividends. The yield, expressed as a percentage of the fund's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is based on the current annualized rate of dividends paid on stocks in the index. 9 12 PERFORMANCE SUMMARY PRIMECAP FUND All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely, so an investment in the fund could lose money.
TOTAL INVESTMENT RETURNS: NOVEMBER 1, 1984-DECEMBER 31, 1998 - -------------------------------------------------------------- PRIMECAP FUND S&P 500 - -------------------------------------------------------------- FISCAL CAPITAL INCOME TOTAL TOTAL YEAR RETURN RETURN RETURN RETURN - -------------------------------------------------------------- 1984 4.9% 0.0% 4.9% 0.6% 1985 35.6 0.2 35.8 31.8 1986 21.8 1.7 23.5 18.7 1987 -3.2 0.9 -2.3 5.3 1988 13.7 1.0 14.7 16.6 1989 20.2 1.4 21.6 31.7 1990 -3.8 1.0 -2.8 -3.1 1991 31.8 1.3 33.1 30.5 1992 8.2 0.8 9.0 7.6 1993 17.6 0.4 18.0 10.1 1994 10.7 0.7 11.4 1.3 1995 34.4 1.1 35.5 37.6 1996 17.5 0.8 18.3 23.0 1997 36.1 0.7 36.8 33.4 1998 24.5 0.9 25.4 28.6
See Financial Highlights table on page 15 for dividend and capital gains information for the past five years.
CUMULATIVE PERFORMANCE: DECEMBER 31, 1988-December 31, 1998 - ------------------------------------------------------------- PRIMECAP Average S&P Fund Growth Fund 500 Index 1988 12 10000 10000 10000 1989 03 10622 10687 10709 1989 06 11261 11529 11654 1989 09 12291 12706 12902 1989 12 12161 12544 13169 1990 03 12258 12239 12772 1990 06 13198 13108 13576 1990 09 10351 11011 11710 1990 12 11822 11857 12760 1991 03 14562 13902 14613 1991 06 14116 13772 14580 1991 09 14649 14833 15359 1991 12 15740 16136 16647 1992 03 15607 15907 16227 1992 06 15156 15427 16535 1992 09 15311 15938 17057 1992 12 17155 17393 17916 1993 03 18036 17795 18698 1993 06 18504 17906 18789 1993 09 19483 18800 19275 1993 12 20248 19234 19721 1994 03 20178 18469 18973 1994 06 20343 18080 19053 1994 09 22075 19067 19985 1994 12 22558 18821 19982 1995 03 24807 20096 21927 1995 06 28262 22103 24020 1995 09 30675 24000 25929 1995 12 30563 24618 27490 1996 03 31601 25786 28966 1996 06 33193 27010 30266 1996 09 33743 27814 31202 1996 12 36159 29354 33802 1997 03 37874 28815 34708 1997 06 43781 33481 40768 1997 09 52419 37137 43821 1997 12 49462 36781 45080 1998 03 54641 41177 51368 1998 06 55371 41979 53064 1998 09 48158 36602 47786 1998 12 62048 45189 57963
- ------------------------------------------------------------------------------------------ AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED DECEMBER 31, 1998 ------------------------------- FINAL VALUE OF A 1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT - ------------------------------------------------------------------------------------------ PRIMECAP Fund 25.44% 25.10% 20.03% $62,048 Average Growth Fund 22.86 18.63 16.28 45,189 S&P 500 Index 28.58 24.06 19.21 57,963 - ------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1998 - -------------------------------------------------------------------------------------------- 10 YEARS INCEPTION --------------------------- DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL - -------------------------------------------------------------------------------------------- PRIMECAP Fund 11/1/1984 25.44% 25.10% 19.11% 0.92% 20.03% - --------------------------------------------------------------------------------------------
10 13 FINANCIAL STATEMENTS DECEMBER 31, 1998 [PHOTO] STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, bonds, etc.) and by industry sector. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets on both a dollar and per-share basis. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values.
- ---------------------------------------------------------------------- MARKET VALUE* PRIMECAP FUND SHARES (000) - ---------------------------------------------------------------------- COMMON STOCKS (93.8%) - ---------------------------------------------------------------------- AUTO & TRANSPORTATION (14.8%) - - AMR Corp. 5,675,000 $ 336,953 (1)Airborne Freight Corp. 3,400,000 122,612 Arvin Industries, Inc. 740,000 30,849 Delta Air Lines, Inc. 7,000,000 364,000 - - FDX Corp. 6,240,000 555,360 Fleetwood Enterprises, Inc. 1,680,600 58,401 Southwest Airlines Co. 8,662,500 194,365 ------------ 1,662,540 ------------ CONSUMER DISCRETIONARY (7.6%) Block Drug Co. Class A 278,100 12,063 - - Costco Cos., Inc. 3,500,000 252,656 Dillard's Inc. 1,241,500 35,227 - - Filene's Basement Corp. 995,000 2,363 - - GC Cos. 200,000 8,325 The Gap, Inc. 172,500 9,703 (1)Harcourt General, Inc. 3,005,900 159,876 Lowe's Cos., Inc. 438,000 22,420 Manpower Inc. 2,720,000 68,510 (1)The McClatchy Co. Class A 1,000,000 35,375 - -(1)Neiman Marcus Group Inc. 3,230,000 80,548 NIKE, Inc. Class B 176,000 7,139 Nordstrom, Inc. 465,000 16,130 - -(1)Plantronics, Inc. 1,608,000 138,288 ------------ 848,623 ------------ CONSUMER STAPLES (1.8%) Brown-Forman Corp. Class B 800,000 60,550 The Seagram Co. Ltd. 3,600,000 136,800 ------------ 197,350 ------------ ENERGY (1.1%) Noble Affiliates, Inc. 2,100,000 51,712 (1)Pogo Producing Co. 2,600,000 33,800 Union Pacific Resources Group, Inc. 3,900,000 35,344 ------------ 120,856 ------------ FINANCIAL SERVICES (2.9%) American International Group, Inc. 1,255,386 121,302 City National Corp. 621,485 25,869 St. Paul Cos., Inc. 1,000,000 34,750 State Street Corp. 400,000 27,825 Torchmark Corp. 2,100,000 74,156 Transatlantic Holdings, Inc. 562,500 42,504 ------------ 326,406 ------------ HEALTH CARE (13.5%) - - Boston Scientific Corp. 2,000,000 53,625 Guidant Corp. 5,210,632 574,472 Johnson & Johnson 1,100,000 92,262 Eli Lilly & Co. 946,640 84,133 Medtronic, Inc. 1,996,888 148,269 Novartis AG ADR 1,200,000 120,300 Pharmacia & Upjohn, Inc. 7,676,900 434,704 ------------ 1,507,765 ------------ MATERIALS & PROCESSING (4.7%) Belden, Inc. 783,000 16,590 Engelhard Corp. 5,200,000 101,400 (1)Granite Construction Co. 2,100,000 70,481 (1)MacDermid, Inc. 1,701,000 66,552 OM Group, Inc. 1,140,000 41,610
11 14
- ---------------------------------------------------------------------- MARKET VALUE* PRIMECAP FUND SHARES (000) - ---------------------------------------------------------------------- Pioneer Hi-Bred International, Inc. 1,350,000 $ 36,450 Potash Corp. of Saskatchewan, Inc. 1,800,000 114,975 Stepan Co. 240,300 6,398 Temple-Inland Inc. 1,300,000 77,106 ------------ 531,562 ------------ PRODUCER DURABLES (10.3%) Caterpillar, Inc. 1,810,000 83,260 Deere & Co. 1,450,000 48,031 - - Dionex Corp. 1,020,000 37,358 Donaldson Co., Inc. 1,080,000 22,410 Flowserve Corp. 732,552 12,133 Kennametal, Inc. 1,260,000 26,775 - - Lexmark International Group, Inc. Class A 700,000 70,350 (1)Millipore Corp. 2,820,000 80,194 Molex, Inc. 195,312 7,446 Molex, Inc. Class A 195,312 6,226 Nokia Corp. A ADR 860,000 103,576 Northern Telecom Ltd. 5,087,300 255,001 Pall Corp. 750,000 18,984 Perkin-Elmer Corp. 1,300,000 126,831 Pitney Bowes, Inc. 2,400,000 158,550 (1)Tektronix, Inc. 3,400,000 102,213 ------------ 1,159,338 ------------ TECHNOLOGY (31.7%) COMMUNICATIONS TECHNOLOGY (5.4%) LM Ericsson Telephone Co. ADR Class B 9,200,000 220,225 LM Ericsson Telephone Co. 4.25% Cvt. Pfd. 620 3,953 Motorola, Inc. 4,280,000 261,348 - - Tellabs, Inc. 1,800,000 123,413 COMPUTER SERVICES, SOFTWARE & SYSTEM (3.1%) (1)Adobe Systems, Inc. 5,190,000 242,633 - -(1)The SABRE Group Holdings, Inc. 2,309,200 102,759 - - Tripos Inc. 95,000 724 COMPUTER TECHNOLOGY (4.5%) Compaq Computer Corp. 6,228,925 261,226 - -(1)Evans & Sutherland Computer Corp. 840,000 14,805 Hewlett-Packard Co. 3,380,000 230,896 ELECTRONICS (1.9%) Sony Corp. ADR 2,869,000 205,851 ELECTRONICS--SEMICONDUCTORS/COMPONENTS (15.5%) Intel Corp. 4,075,000 483,142 - - LSI Logic Corp. 1,488,700 24,005 - - Micron Technology, Inc. 10,300,000 520,794 Texas Instruments, Inc. 6,990,000 598,082 - - Xilinx, Inc. 1,700,000 110,713 ELECTRONICS--TECHNOLOGY (1.3%) - -(1)Coherent, Inc. 1,800,000 22,388 Symbol Technologies, Inc. 2,000,000 127,875 ------------ 3,554,832 ------------ OTHER (5.4%) - - Berkshire Hathaway, Inc. Class B 26,250 61,688 Miscellaneous (4.8%) 542,807 ------------ 604,495 ------------ - ---------------------------------------------------------------------- TOTAL COMMON STOCKS (COST $6,039,731) 10,513,767 - ---------------------------------------------------------------------- FACE AMOUNT (000) - ---------------------------------------------------------------------- TEMPORARY CASH INVESTMENT (6.5%) - ---------------------------------------------------------------------- REPURCHASE AGREEMENT Collateralized by U.S. Government Obligations in a Pooled Cash Account 4.76%, 1/4/1999 (Cost $728,658) $728,658 728,658 - ---------------------------------------------------------------------- TOTAL INVESTMENTS (100.3%) (COST $6,768,389) 11,242,425 - ---------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-0.3%) - ---------------------------------------------------------------------- Other Assets--Note C 66,534 Liabilities (99,073) ------------ (32,539) - ---------------------------------------------------------------------- NET ASSETS (100%) - ---------------------------------------------------------------------- Applicable to 235,209,944 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $11,209,886 ====================================================================== NET ASSET VALUE PER SHARE $47.66 ======================================================================
* See Note A in Notes to Financial Statements. - - Non-Income-Producing Security. (1)Considered an affiliated company as the fund owns more than 5% of the outstanding voting securities of such company. The total market value of investments in affiliated companies was $1,273,000,000. ADR--American Depositary Receipt.
- ---------------------------------------------------------------------- AT DECEMBER 31, 1998, NET ASSETS CONSISTED OF: - ---------------------------------------------------------------------- AMOUNT PER (000) SHARE - ---------------------------------------------------------------------- Paid in Capital 6,589,740 $28.02 Overdistributed Net Investment Income (3,059) (.01) Accumulated Net Realized Gains 149,169 .63 Unrealized Appreciation-- Note F 4,474,036 19.02 - ---------------------------------------------------------------------- NET ASSETS $11,209,886 $47.66 ======================================================================
12 15 STATEMENT OF OPERATIONS This Statement shows dividend and interest income earned by the fund during the reporting period, and details the operating expenses charged to the fund. These expenses directly reduce the amount of investment income available to pay to shareholders as dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) on investments during the period.
- --------------------------------------------------------------------------------------------- PRIMECAP FUND YEAR ENDED DECEMBER 31, 1998 (000) - --------------------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 59,285 Interest 66,712 Security Lending 748 ----------- Total Income 126,745 ----------- EXPENSES Investment Advisory Fees--Note B 20,669 The Vanguard Group--Note C Management and Administrative 26,595 Marketing and Distribution 2,214 Taxes (other than income taxes) 374 Custodian Fees 23 Auditing Fees 15 Shareholders' Reports 204 Annual Meeting and Proxy Costs 48 Trustees' Fees and Expenses 20 ----------- Total Expenses 50,162 Expenses Paid Indirectly--Note D (2) ----------- Net Expenses 50,160 - --------------------------------------------------------------------------------------------- NET INVESTMENT INCOME 76,585 - --------------------------------------------------------------------------------------------- REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 433,652 - --------------------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 1,697,719 - --------------------------------------------------------------------------------------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 2,207,956 =============================================================================================
*Dividend income from affiliated companies was $7,545,000. 13 16 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the amount shareholders invested in the fund, either by purchasing shares or by reinvesting distributions, as well as the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed are shown at the end of the Statement.
- -------------------------------------------------------------------------------------------------- PRIMECAP FUND YEAR ENDED DECEMBER 31, ---------------------------------- 1998 1997 (000) (000) - -------------------------------------------------------------------------------------------------- INCREASE IN NET ASSETS OPERATIONS Net Investment Income $ 76,585 $ 42,005 Realized Net Gain 433,652 289,401 Change in Unrealized Appreciation (Depreciation) 1,697,719 1,327,647 --------------------------------- Net Increase in Net Assets Resulting from Operations 2,207,956 1,659,053 --------------------------------- DISTRIBUTIONS Net Investment Income (80,088) (39,529) Realized Capital Gain (348,822) (248,608) --------------------------------- Total Distributions (428,910) (288,137) --------------------------------- CAPITAL SHARE TRANSACTIONS(1) Issued 3,038,897 3,307,320 Issued in Lieu of Cash Distributions 418,210 282,274 Redeemed (2,212,430) (978,333) --------------------------------- Net Increase from Capital Share Transactions 1,244,677 2,611,261 - -------------------------------------------------------------------------------------------------- Total Increase 3,023,723 3,982,177 - -------------------------------------------------------------------------------------------------- NET ASSETS Beginning of Year 8,186,163 4,203,986 --------------------------------- End of Year $ 11,209,886 $ 8,186,163 ================================================================================================== (1)Shares Issued (Redeemed) Issued 71,476 85,932 Issued in Lieu of Cash Distributions 9,174 7,480 Redeemed (52,348) (26,285) --------------------------------- Net Increase in Shares Outstanding 28,302 67,127 ==================================================================================================
14 17 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis. It also presents the fund's Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
- ------------------------------------------------------------------------------------------------------------------------------------ PRIMECAP FUND YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------- FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF YEAR $ 39.56 $ 30.08 $ 26.23 $ 19.98 $ 18.42 - ------------------------------------------------------------------------------------------------------------------------------------ INVESTMENT OPERATIONS Net Investment Income .34 .21 .19 .22 .12 Net Realized and Unrealized Gain (Loss) on Investments 9.63 10.77 4.59 6.84 1.97 ----------------------------------------------------------------------- Total from Investment Operations 9.97 10.98 4.78 7.06 2.09 ----------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.35) (.20) (.20) (.22) (.12) Distributions from Realized Capital Gains (1.52) (1.30) (.73) (.59) (.41) ----------------------------------------------------------------------- Total Distributions (1.87) (1.50) (.93) (.81) (.53) - ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, END OF YEAR $ 47.66 $ 39.56 $ 30.08 $ 26.23 $ 19.98 ==================================================================================================================================== TOTAL RETURN 25.44% 36.79% 18.31% 35.48% 11.41% ==================================================================================================================================== RATIOS/SUPPLEMENTAL DATA Net Assets, End of Year (Millions) $ 11,210 $ 8,186 $ 4,204 $ 3,237 $ 1,554 Ratio of Total Expenses to Average Net Assets 0.51% 0.51% 0.59% 0.58% 0.64% Ratio of Net Investment Income to Average Net Assets 0.78% 0.69% 0.69% 0.99% 0.79% Portfolio Turnover Rate 13% 13% 10% 7% 8% ====================================================================================================================================
15 18 NOTES TO FINANCIAL STATEMENTS Vanguard PRIMECAP Fund is registered under the Investment Company Act of 1940 as a diversified open-end investment company, or mutual fund. A. The following significant accounting policies conform to generally accepted accounting principles for mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Temporary cash investments are valued at cost, which approximates market value. Securities for which market quotations are not readily available are valued by methods deemed by the Board of Trustees to represent fair value. 2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Accordingly, no provision for federal income taxes is required in the financial statements. 3. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account, which is invested in repurchase agreements secured by U.S. government securities. Securities pledged as collateral for repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings. 4. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. 5. OTHER: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. B. PRIMECAP Management provides investment advisory services to the fund for a fee calculated at an annual percentage rate of average net assets. For the year ended December 31, 1998, the advisory fee represented an effective annual rate of 0.21% of the fund's average net assets. C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by the Board of Trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At December 31, 1998, the fund had contributed capital of $1,862,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 2.6% of Vanguard's capitalization. The fund's Trustees and officers are also Directors and officers of Vanguard. D. The fund's custodian bank has agreed to reduce its fees when the fund maintains cash on deposit in the non-interest-bearing custody account. For the year ended December 31, 1998, custodian fee offset arrangements reduced expenses by $2,000. E. During the year ended December 31, 1998, the fund purchased $2,405,298,000 of investment securities and sold $1,146,875,000 of investment securities, other than temporary cash investments. F. At December 31, 1998, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $4,474,036,000, consisting of unrealized gains of $4,842,597,000 on securities that had risen in value since their purchase and $368,561,000 in unrealized losses on securities that had fallen in value since their purchase. 16 19 REPORT OF INDEPENDENT ACCOUNTANTS [PHOTO] To the Shareholders and Trustees of Vanguard PRIMECAP Fund In our opinion, the accompanying statement of net assets and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Vanguard PRIMECAP Fund (the "Fund") at December 31, 1998, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the five years in the period then ended, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at December 31, 1998 by correspondence with the custodian, provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Thirty South Seventeenth Street Philadelphia, Pennsylvania 19103 February 2, 1999 17 20 SPECIAL 1998 TAX INFORMATION (UNAUDITED) FOR VANGUARD PRIMECAP FUND This information for the fiscal year ended December 31, 1998, is included pursuant to provisions of the Internal Revenue Code. The fund distributed $260,706,000 as capital gain dividends (from net long-term capital gains) to shareholders during the fiscal year ended December 1998, all of which is designated as a 20% rate gain distribution. For corporate shareholders, 29.1% of investment income (dividend income plus short-term gains, if any) qualifies for the dividends-received deduction. 18 21 TRUSTEES AND OFFICERS JOHN C. BOGLE Founder, Senior Chairman of the Board, and Director/Trustee of The Vanguard Group, Inc., and each of the investment companies in The Vanguard Group. JOHN J. BRENNAN Chairman of the Board, Chief Executive Officer, and Director/Trustee of The Vanguard Group, Inc., and each of the investment companies in The Vanguard Group. BARBARA BARNES HAUPTFUHRER Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions, Inc., Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance Co., and Ladies Professional Golf Association; Trustee Emerita of Wellesley College. JOANN HEFFERNAN HEISEN Vice President, Chief Information Officer, and a member of the Executive Committee of Johnson & Johnson; Director of Johnson & Johnson-Merck Consumer Pharmaceuticals Co., Women First HealthCare, Inc., Recording for the Blind and Dyslexic, The Medical Center at Princeton, and Women's Research and Education Institute. BRUCE K. MACLAURY President Emeritus of The Brookings Institution; Director of American Express Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp. BURTON G. MALKIEL Chemical Bank Chairman's Professor of Economics, Princeton University; Director of Prudential Insurance Co. of America, Banco Bilbao Gestinova, Baker Fentress & Co., The Jeffrey Co., and Southern New England Telecommunications Co. ALFRED M. RANKIN, JR. Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co. JOHN C. SAWHILL President and Chief Executive Officer of The Nature Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and President of New York University; Director of Pacific Gas and Electric Co., Procter & Gamble Co., NACCO Industries, and Newfield Exploration Co. JAMES O. WELCH, JR. Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp. J. LAWRENCE WILSON Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins Engine Co. and The Mead Corp.; Trustee of Vanderbilt University. OTHER FUND OFFICERS RAYMOND J. KLAPINSKY Secretary; Managing Director and Secretary of The Vanguard Group, Inc.; Secretary of each of the investment companies in The Vanguard Group. THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of The investment companies in the Vanguard Group. KAREN E. WEST Controller; Principal of The Vanguard Group, Inc.; Controller of each of the investment companies in The Vanguard Group. OTHER VANGUARD OFFICERS R. GREGORY BARTON Managing Director, Legal Department. ROBERT A. DISTEFANO Managing Director, Information Technology. JAMES H. GATELY Managing Director, Individual Investor Group. KATHLEEN C. GUBANICH Managing Director, Human Resources. IAN A. MACKINNON Managing Director, Fixed Income Group. F. WILLIAM MCNABB, III Managing Director, Institutional Investor Group. MICHAEL S. MILLER Managing Director, Planning and Development. RALPH K. PACKARD Managing Director and Chief Financial Officer. GEORGE U. SAUTER Managing Director, Core Management Group. "STANDARD & POOR'S(R)," "S&P(R)," "S&P 500(R)," "STANDARD & POOR'S 500," AND "500" ARE TRADEMARKS OF THE MCGRAW-HILL COMPANIES, INC. FRANK RUSSELL COMPANY IS THE OWNER OF TRADEMARKS AND COPYRIGHTS RELATING TO THE RUSSELL INDEXES. "WILSHIRE 4500" AND "WILSHIRE 5000" ARE TRADEMARKS OF WILSHIRE ASSOCIATES. 22 VANGUARD MILESTONES [GRAPHIC] The Vanguard Group is named for HMS Vanguard, Admiral Horatio Nelson's flagship at the Battle of the Nile on August 1, 1798. Our founder, John C. Bogle, chose the name after reading Nelson's inspiring tribute to his fleet: "Nothing could withstand the squadron . . . with the judgment of the captains, together with their valour, and that of the officers and men of every description, it was absolutely irresistible." [GRAPHIC] Walter L. Morgan, founder of Wellington Fund, the nation's oldest balanced mutual fund and forerunner of today's family of some 100 Vanguard funds, celebrated his 100th birthday on July 23, 1998. Mr. Morgan, a true investment pioneer, died six weeks later on September 2. [GRAPHIC] Wellington Fund, The Vanguard Group's oldest fund, was incorporated by Mr. Morgan 70 years ago, on December 28, 1928. The fund was named after the Duke of Wellington, whose forces defeated Napoleon Bonaparte at the Battle of Waterloo in 1815. [THE VANGUARD GROUP LOGO] Post Office Box 2600 Valley Forge, Pennsylvania 19482 FUND INFORMATION 1-800-662-7447 INDIVIDUAL ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 www.vanguard.com online@vanguard.com All Vanguard funds are offered by prospectus only. Prospectuses contain more complete information on advisory fees, distribution charges, and other expenses and should be read carefully before you invest or send money. Prospectuses can be obtained directly from The Vanguard Group. Q590-02/12/1999 (C) 1999 Vanguard Marketing Corporation, Distributor. All rights reserved. -----END PRIVACY-ENHANCED MESSAGE-----