0000932471-01-500403.txt : 20011029 0000932471-01-500403.hdr.sgml : 20011029 ACCESSION NUMBER: 0000932471-01-500403 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010830 FILED AS OF DATE: 20011023 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: 1940 Act SEC FILE NUMBER: 811-04098 FILM NUMBER: 1764178 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 primecap2001.txt VANGUARD PRIMECAP FUND ANNUAL REPORT VANGUARD(R) PRIMECAP FUND Annual Report * August 31, 2001 STOCK [PHOTO OF SHIP ON OCEAN] [THE VANGUARD GROUP(R) LOGO] September 11, 2001 On September 11, as we were preparing this report, a series of attacks on our nation by terrorists claimed thousands of lives. We want to convey, on behalf of Vanguard's 11,000 crew members, our profound sense of anguish for the victims of the attacks and their families, friends, and colleagues. Despite the huge loss of life, the tremendous physical destruction, and the widespread disruption of commerce caused by these attacks, we are confident that the people, financial markets, and economy of the United States will move forward. The adaptability and resolve of our people, the resiliency of our markets, and the inherent strength of our economic system have overcome many severe tests in the past 200 years. We believe they will do so again. Finally, we salute our clients, who responded to the events of September 11 and their aftermath with patience, reason, and a long-term, not short-term, perspective. We feel privileged to serve such investors. -- John J. Brennan Chairman and Chief Executive Officer -------------------------------------------------------------------------------- CONTENTS LETTER FROM THE CHAIRMAN 1 REPORT FROM THE ADVISER 6 FUND PROFILE 10 GLOSSARY OF INVESTMENT TERMS 11 PERFORMANCE SUMMARY 12 REPORT ON AFTER-TAX RETURNS 13 FINANCIAL STATEMENTS 14 ADVANTAGES OF VANGUARD.COM 23 SUMMARY * Vanguard PRIMECAP Fund returned -13.4% during the eight months ended August 31-- a result that reflected the weakness in many parts of the stock market. * The fund's return was in line with that of the S&P 500 Index, but was slightly short of the result for multi-cap core funds. * The fund's fiscal year-end has moved from December 31 to August 31. The shift, which does not affect the fund's objectives or policies, means that this report covers the eight-month period since December 31. LETTER FROM THE CHAIRMAN Fellow Shareholder, [PHOTO OF JOHN J. BRENNAN] JOHN J. BRENNAN VANGUARD PRIMECAP FUND returned -13.4% during the eight months ended August 31, 2001, as the economic outlook worsened and the stock market's troubles persisted. Clearly, the economic and financial landscape was significantly altered by the tragic events of September 11. This reporting period, however, concluded before the terrorist attacks, and our letter therefore reflects the fund's perfor-mance through August. As we noted in our semiannual report to you two months ago, the fund's fiscal year-end has moved from December 31 to August 31. As a result, this report covers a shortened fiscal year--the eight months since January 1, 2001. In the future, you will receive a semiannual report covering the six months from September 1 through February, and an annual report covering the 12 months through August. The table below presents the returns for the fund, its average peer, and the S&P 500 Index, a measure of large-capitalization U.S. stocks. As you can see, your fund's return over the eight months was in line with that of the S&P 500 Index, but slightly behind that of its average competitor. The fund's total return is based on a decrease in net asset value from $60.38 per share on December 31, 2000, to $51.90 per share on August 31, 2001, and is adjusted for a dividend of $0.02 per share paid from net investment income and a distribution of $0.39 per share paid from net realized capital gains. -------------------------------------------------- 2001 TOTAL RETURNS DECEMBER 31, 2000, THROUGH AUGUST 31, 2001 -------------------------------------------------- Vanguard PRIMECAP Fund -13.4% Average Multi-Cap Core Fund* -12.6 S&P 500 Index -13.4 -------------------------------------------------- *Derived from data provided by Lipper Inc. If you own Vanguard PRIMECAP Fund in a taxable account, you may wish to review our report on the fund's after-tax returns on page 13. FINANCIAL MARKETS IN REVIEW Global economic activity slowed considerably faster than predicted during the 12 months ended August 31. With corporate profits plunging, capital spending declined sharply: From January through June 2001, worldwide industrial production fell an estimated 6%. All of the world's major central banks responded to the economic downturn by lowering interest rates. No central bank cut rates faster or further than the U.S. Federal Reserve Board. As shown in the chart on page 2, the Fed reduced its target 1 -------------------------------------------------------------------------------- MARKET BAROMETER AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED AUGUST 31, 2001 ONE THREE FIVE YEAR YEARS YEARS -------------------------------------------------------------------------------- STOCKS S&P 500 Index (Large-caps) -24.4% 7.1% 13.3% Russell 2000 Index (Small-caps) -11.6 13.0 8.4 Wilshire 5000 Index (Entire market) -25.6 7.4 11.8 MSCI EAFE Index (International) -24.4 1.4 2.6 -------------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index (Entire market) 12.4% 6.8% 8.2% Lehman 10 Year Municipal Bond Index 9.6 5.8 7.0 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 5.3 5.1 5.2 -------------------------------------------------------------------------------- CPI Consumer Price Index 2.7% 2.8% 2.4% -------------------------------------------------------------------------------- for short-term interest rates from 6.50% to 3.50% over a span of 8 months. U.S. policymakers hoped that the reduced cost of borrowing would prompt a rebound in capital spending by businesses and shore up consumer confidence. However, corporate spending remained low, as numerous companies faced earnings declines and, in many cases, significant overcapacity. An upturn in unemployment to 4.9% of the workforce made consumers more cautious. Even so, consumer spending, which accounts for two-thirds of U.S. economic activity, proved just sufficient to keep the overall economy from shrinking during the fiscal year. Although U.S. economic growth continued, it was barely perceptible. According to an estimate from the Commerce Department, the economy expanded at an inflation-adjusted annual rate of 0.3% in the second quarter of 2001. And the trend was downward: This anemic rise in real gross domestic product followed increases of 1.9% in the fourth quarter of 2000 and 1.3% in the first quarter of 2001. As economic output slowed, so did the growth rate of productivity--the value of goods and services that American -------------------------------------------------------------------------------- FEDERAL RESERVE INTEREST RATE CUTS (12 months ended August 31, 2001) CHANGES IN TARGET FEDERAL FUNDS RATE The federal funds rate is the level of interest that banks charge each other for overnight loans made through the Federal Reserve System. By setting a target for that rate, the Fed hopes to influence short-term rates charged by banks. [CHART APPEARS HERE] [SCALE 3.0% TO 7.0%] 2000 6.50% Jan. 3, 2001 6.00 Jan. 31, 2001 5.50 Mar. 20, 2001 5.00 Apr. 18, 2001 4.50 May 15, 2001 4.00 June 27, 2001 3.75 Aug. 21, 2001 3.00 -------------------------------------------------------------------------------- Source: Federal Reserve Board. 2 workers produce per hour of labor. In the second quarter, productivity improved at an annualized rate of 2.1%. During the five years ended December 31, 2000, the average annual gain was 2.6%. Amid the economic downturn, stock prices fell around the world. Bonds, however, delivered terrific results. Large-capitalization U.S. stocks, as measured by the Standard & Poor's 500 Index, recorded a total return of -24.4% during the 12 months ended August 31. Small- and mid-cap stocks, as measured by the Wilshire 4500 Completion Index, fared even worse, declining -32.3%. There were pockets of strength among stocks, however. Mid- and small-cap value stocks--issues that trade at relatively low prices compared with their book values or earnings--delivered solid gains. The S&P MidCap 400/BARRA Value Index returned 16.9%, while the Russell 2000 Value Index gained 18.0%. In sharp contrast, growth stocks of all sizes recorded double-digit declines. Technology stocks, in particular, continued to suffer--the tech-heavy Nasdaq Composite Index declined -56.6% during the 12 months ended August 31. From its peak in March 2000, the Nasdaq has now fallen about -60%. The Lehman Brothers Aggregate Bond Index returned a stellar 12.4% during the period. Falling interest rates boosted prices, particularly at the short end of the maturity spectrum. Yields on 3-month Treasury bills, which closely track Fed policy shifts, fell nearly 300 basis points (3 percentage points). Rates on intermediate- and long-term bonds fell, but by far less. FISCAL 2001 PERFORMANCE OVERVIEW During the abbreviated fiscal year--the eight months through August 31--your fund's return was in line with the decline registered by large-cap stocks, but was lower than the average result of its peer funds. ---------------------- THE FUND'S RETURN WAS IN LINE WITH THE DECLINE REGISTERED BY LARGE-CAP STOCKS, BUT WAS A BIT LOWER THAN THE AVERAGE RESULT FOR ITS COMPETITORS. ---------------------- The story of the PRIMECAP Fund's perfor-mance over the past eight months is, not surprisingly, similar to that of our six-month performance, which we reported to you two months ago. Detracting from performance was the fund's large stake in the still-reeling technology sector. In addition, our results were hurt by our investments in health care stocks, particularly big pharmaceutical companies, which have been hit hard over the past year. On the positive side, PRIMECAP's retail stocks held up fairly well, and several telecommunications holdings have registered relatively strong performances. See the Report from the Adviser, which begins on page 6, for more details on the fund's holdings. 3 Since our last report to you dated June 30, 2001, the PRIMECAP Fund has returned -6.7%, in line with our peers and a bit ahead of the broader market. We know that sustaining a loss on an investment is difficult, and we thank you for sticking with the fund--and with Vanguard--through this challenging period in the financial markets. LONG-TERM PERFORMANCE OVERVIEW We believe investors are best served by focusing on the long term--in both rewarding and challenging periods. As you can see in the table below, PRIMECAP's performance record over the past ten years is terrific, both on an absolute basis and relative to competing funds and broader market measures. Even with the disappointing stock market results of the past 18 months, the fund's average return over the decade was a remarkable 18.1% a year. This fine performance was the result of a generally favorable market environment and, notably, the skilled investment management of your fund's investment adviser, PRIMECAP Management Company. The success of PRIMECAP Management, which has managed the fund since its inception in 1984, is especially impressive when viewed in terms of the wealth it has helped investors to build. Over the past ten years, a hypothetical $25,000 investment in the PRIMECAP Fund would have grown to more than $132,432--more than a five-fold increase. -------------------------------------------------------------- TOTAL RETURNS TEN YEARS ENDED AUGUST 31, 2001 ---------------------------- AVERAGE FINAL VALUE OF ANNUAL A $25,000 RETURN INITIAL INVESTMENT -------------------------------------------------------------- Vanguard PRIMECAP Fund 18.1% $132,432 Average Multi-Cap Core Fund 11.8 76,453 S&P 500 Index 13.5 88,387 -------------------------------------------------------------- Of course, we do not expect the market or your fund to match these stellar performances in the years to come. In fact, it would be unwise for investors to expect any investment to provide such an above-average return over a long period. But while the past truly does not foretell the future, we believe your fund will provide long-term returns that are superior to those of its peers. We base this belief on the skill of our investment adviser and on our low costs, which provide our shareholders with an important advantage year in and year out--and especially over the long run. Our fund's annualized expense ratio (annualized expenses as a percentage of average net assets) is 0.50%, or $5.00 per $1,000 invested, versus the 1.36% ($13.60 per $1,000) charged by the average multi-cap core fund, according to data from Lipper Inc. IN SUMMARY The past several years in the financial markets have marked a period of extremes. The spectacular equity returns of the late 1990s have been 4 followed by generally dismal results. But just as we urged investors to assume that the stock market would encounter rough seas from time to time, we are now encouraging investors to understand that market declines always come to an end. Of course, exactly when and why markets change direction is not predictable. To avoid being whipsawed by market shifts, we recommend holding a mix of stock funds, bond funds, and money market funds that is right for your goals and your tolerance for risk. Once you have such a plan in place, the best course of action is to stick with it, no matter which way the financial markets are headed. Sincerely, /S/ JOHN J. BRENNAN John J. Brennan Chairman and Chief Executive Officer September 13, 2001 5 REPORT FROM THE ADVISER For the eight months ended August 31, 2001, vanguard primecap fund returned -13.4%. This result was identical to the return of the unmanaged S&P 500 Index and behind the -12.6% return of the average multi-cap core fund. Plainly, it was a very disappointing period for the fund. THE INVESTMENT ENVIRONMENT The marked change in the investment environment that began in mid-2000 continued in fiscal 2001. Investing in technology stocks proved an especially difficult exercise, as we suggested it would in our letter to you last January. The sector declined -32.7% in the eight months through August 31, bringing its slide for the 12 months ended August 31 to a staggering -62.8%. Health care stocks, which typically are a safe haven during times of economic weakness, fell -13.1% over the past eight months. Energy stocks, which soared in 2000 coincident with the prices of oil and gas, have fallen this year. The "other energy" sector turned in the worst performance in the eight-month period, plummeting -33.7%, as oil and gas prices moderated, supply increased, and inventories began to build. Despite an obviously slowing economy, consumers remained remarkably buoyant during the first six months or so of 2001, although their confidence levels fell during the summer and have been badly shaken by the horrifying terrorist attacks that occurred on September 11, after the end of our fiscal year. The attack has significantly curtailed near-term economic activity and consumer and investor expectations. Before September 11, automobile sales, which traditionally fall sharply in a weak economy, had stayed at a level well above expectations and historical norms. The relatively strong pace of auto sales, combined with moderating fuel costs, resulted in a 2.5% return for the auto & transportation sector, one of only two groups to post positive returns during the eight months ended August 31. Consumer discretionary stocks, another beneficiary of the generally firm trend in consumer spending, were the third-strongest sector in the market, declining "only" -1.2%. The materials & processing sector, with a 2.7% return, was the best-performing group during the period. -------------------------------------------------------------------------------- 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. -------------------------------------------------------------------------------- 6 OUR SUCCESSES In December's report to you, we identified consumer discretionary stocks as the area of greatest increased focus for the fund. On average, 10.4% of the fund's assets were invested in this sector during the past eight months, compared with 6.3% for all of 2000. In retrospect, this increase in our allocation proved timely, given that this sector suffered less than most others. Results from our selections in this group significantly exceeded the performance of the index's holdings (+14.8% versus -1.2%), and it was the PRIMECAP Fund's best-performing group. We noted then that we had added four high-quality retailers (Lowe's, Target, Best Buy, and TJX), along with Eastman Kodak. Each of these stocks turned out to be an excellent performer in fiscal 2001. Best Buy led the pack, surging 99.5%. Lowe's jumped 67.5%. TJX, Eastman Kodak, and Target recorded more moderate gains of 27.0%, 16.7%, and 7.9%, respectively. Our December report also outlined our view on the rationalization and consolidation under way in the telecommunications market. We mentioned initiating positions in WorldCom and Sprint. Sprint's 16.2% return led the fund's utilities holdings to a 9.7% gain in the eight-month period, making this our second-best-performing sector. (Utilities within the S&P 500 Index recorded a decline of -8.9%.) We also initiated a major position in UtiliCorp United, an international electric and gas company whose 83%-owned subsidiary, Aquila, is a rapidly growing wholesaler of electricity and natural gas. OUR SHORTFALLS The fund's significant commitment to technology hurt our results during the eight months ended August 31. Although returns for our selections outpaced those of the index group (-25.7% versus -32.7%), the sector was a treacherous one, with very few stocks doing well. The speed and magnitude with which business deteriorated for technology companies was unprecedented and, frankly, astonishing. After several years of strong performance, our health care stocks took a beating in 2001. The sector has been an area of major emphasis for the fund for years and contributed meaningfully to our positive returns in previous years. However, during the past eight months, the fund's health care stocks recorded a -25.1% return, considerably worse than the sector's -13.1% decline in the S&P 500 Index. Typically, companies in the health care area, particularly pharmaceutical companies, are reasonably immune to weak economies. However, several major pharmaceuticals have lowered their earnings estimates for the year, casting doubt on the earnings outlook for the entire industry. In addition, FDA approval for new products from Novartis and Guidant, two of the fund's largest health care holdings, looks 7 less certain than it did when our fiscal year began. Significant declines among our health care stocks included the fund's largest holding, Pharmacia (-34.6%), as well as Guidant (-33.0%) and Novartis (-18.5%). THE FUND'S POSITIONING During the eight months of this shortened fiscal year, the PRIMECAP Fund continued to evolve in line with the changes begun last year and described in December's report to you. As noted earlier, we increased our holdings of consumer discretionary stocks. As of August 31, more than 14% of the fund was committed to this sector, compared with about 9% at the start of this year and 5% at the beginning of 2000. In our judgment, the consumer economy remains considerably healthier than the industrial components of the economy. However, relative valuations are always changing. When we started building positions in the retail group, we viewed the valuations as compelling. The stocks had lagged the market for years. But as our retail holdings have appreciated and the market as a whole has declined, the stocks' valuations on a relative basis are clearly no longer as attractive. We also continued to increase the fund's emphasis on energy and utility stocks. Integrated oils and "other energy" stocks accounted for about 7% of PRIMECAP Fund's assets on August 31, up from about 4% at year-end 2000 and about 1% at the start of 2000. Our utilities holdings, which were nil at the beginning of 2000 and only about 1% at the beginning of 2001, increased to a bit more than 3% on August 31. Although energy prices have moderated from the high levels reached earlier in 2001, we expect to see a protracted period of higher energy prices that will provide attractive returns to suppliers. Consequently, we established significant positions in Phillips Petroleum, Amerada Hess, and, as noted earlier, UtiliCorp United. In the technology sector, the fund's weighting declined to about 32% of total assets, versus about 37% at year-end 2000 and about 47% when 2000 began. Although we have yet to see an upturn in business for the technology companies we track, valuations for selected companies have reached levels that we believe represent significant value. We have added to some existing positions, such as Nortel Networks, and have recently initiated new positions in a few technology names, such as Rational Software. OUR POSITION IN AIRLINE STOCKS Over the years, PRIMECAP Fund has maintained a commitment to airline stocks. Our favorable outlook on the industry was predicated on improving industry fundamentals, low valuations, and slowing capacity growth in terms of available seat miles. However, the cataclysmic events of September 11 abruptly changed the dynamics of the airline industry, as well as those of other sectors in the economy. Facing substantially reduced passenger traffic, significantly 8 increased costs, and restrictions on cargo transport, the industry is on the brink of disaster. As vital as the airline industry is to our economy, we feel confident that the government will offer meaningful financial support to preserve a healthy airline industry. However, the immediate risks to the airline industry are extraordinary. IN SUMMARY The economy and the financial markets have been buffeted by extreme turbulence this year. We have less conviction than usual in assessing which sectors represent the market's next generation of leadership, which is why the portfolio reflects a more balanced weighting among sectors than it has for many years. Howard B. Schow Theo A. Kolokotrones Portfolio Manager Portfolio Manager Joel P. Fried Portfolio Manager PRIMECAP Management Company September 14, 2001 9 FUND PROFILE AS OF AUGUST 31, 2001 FOR PRIMECAP FUND This Profile provides a snapshot of the fund's characteristics, compared where appropriate to an unmanaged index. Key terms are defined on page 11. -------------------------------------------- PORTFOLIO CHARACTERISTICS S&P FUND 500 -------------------------------------------- Number of Stocks 119 500 Median Market Cap $13.0B $55.7B Price/Earnings Ratio 23.6x 25.8x Price/Book Ratio 2.5x 3.6x Yield 0.5% 1.4% Return on Equity 18.9% 24.3% Earnings Growth Rate 21.2% 15.7% Foreign Holdings 5.4% 1.5% Turnover Rate 7% -- Expense Ratio 0.50%* -- Cash Investments 8.6% -- -------------------------------------------- -------------------------------------------- TEN LARGEST HOLDINGS (% of total net assets) Pharmacia Corp. 4.4% (pharmaceuticals) Micron Technology, Inc. 3.9 (electronics) Texas Instruments, Inc. 3.8 (electronics) FedEx Corp. 3.5 (air transportation) Adobe Systems, Inc. 3.4 (software) General Motors Corp. Class H 2.9 (telecommunications) Sabre Holdings Corp. 2.7 (software) AMR Corp. 2.5 (air transportation) Microsoft Corp. 2.4 (software) Phillips Petroleum Co. 2.3 (oil) -------------------------------------------- Top Ten 31.8% -------------------------------------------- -------------------------------------------- VOLATILITY MEASURES S&P FUND 500 -------------------------------------------- R-Squared 0.66 1.00 Beta 0.97 1.00 -------------------------------------------- -------------------------------------------- SECTOR DIVERSIFICATION (% of common stocks) S&P FUND 500 -------------------------------------------- Auto & Transportation 15.4% 1.9% Consumer Discretionary 14.5 12.7 Consumer Staples 0.0 7.7 Financial Services 3.9 19.1 Health Care 11.9 13.9 Integrated Oils 3.9 5.5 Other Energy 2.7 2.0 Materials & Processing 3.9 3.0 Producer Durables 7.2 3.0 Technology 32.1 15.9 Utilities 3.3 9.0 Other 1.2 6.3 -------------------------------------------- -------------------------------- INVESTMENT FOCUS [GRID] MARKET CAP LARGE STYLE GROWTH -------------------------------- [PHOTO OF A COMPUTER] VISIT OUR WEBSITE WWW.VANGUARD.COM FOR REGULARLY UPDATED FUND INFORMATION. *Annualized. 10 GLOSSARY OF INVESTMENT TERMS 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 INVESTMENTS. 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. -------------------------------------------------------------------------------- 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. -------------------------------------------------------------------------------- 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 returns 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. -------------------------------------------------------------------------------- TURNOVER RATE. An indication of the fund's trading activity. 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. -------------------------------------------------------------------------------- 11 PERFORMANCE SUMMARY AS OF AUGUST 31, 2001 FOR 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. An investor's shares, when redeemed, could be worth more or less than their original cost. Note that, except for the final table on the page, average annual returns are based on the fund's new fiscal year-end. -------------------------------------------------------------------------------- CUMULATIVE PERFORMANCE August 31, 1991-August 31, 2001 [CHART APPEARS HERE] [SCALE $10,000 TO $190,000] QUARTER PRIMECAP AVERAGE MULTI-CAP S&P 500 ENDED FUND CORE FUND INDEX -------------------------------------------------------------------------------- 199108 25000 25000 25000 199111 23945 24560 23908 199202 27705 28270 26485 199205 25977 26848 26863 199208 24655 26120 26981 199211 27934 29295 28325 199302 29550 29576 29306 199305 31130 31296 29983 199308 32285 32801 31086 199311 32764 33062 31185 199402 35204 34992 31749 199405 34889 33055 31260 199408 37541 33989 32786 199411 37209 32914 31512 199502 39400 34806 34087 199505 44066 37517 37570 199508 49681 42646 39818 199511 51836 44549 43165 199602 52523 46637 45916 199605 56451 51343 48254 199608 53559 47768 47275 199611 61160 53178 55192 199702 64197 53521 57928 199705 71393 56456 62448 199708 80607 62079 66491 199711 83409 62925 70929 199802 90268 69764 78206 199805 89614 71129 81611 199808 76548 59018 71874 199811 95601 71804 87711 199902 105007 81373 93641 199905 113473 87034 98770 199908 124891 90717 100496 199911 134769 104439 106039 200002 167135 143436 104624 200005 163734 122239 109118 200008 179931 146372 116897 200011 147753 104804 101565 200102 139684 96661 96046 200105 145089 94320 97602 200108 132432 76453 88387 AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED AUGUST 31, 2001 -------------------------------------------- FINAL VALUE ONE FIVE TEN OF A $25,000 YEAR YEARS YEARS INVESTMENT -------------------------------------------------------------------------------- PRIMECAP Fund* -27.13% 19.85% 18.14% $132,432 Average Multi-Cap Core Fund** -22.70 11.24 11.83 76,453 S&P 500 Index -24.39 13.33 13.46 88,387 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- TOTAL INVESTMENT RETURNS (%) August 31, 1991-August 31, 2001 [BAR CHART APPEARS HERE] [SCALE -40% TO 80%] FISCAL PRIMECAP S&P 500 YEAR FUND INDEX -------------------------------------------------------------------------------- 1992 -1.4 7.9 1993 30.9 15.2 1994 16.3 5.5 1995 32.3 21.4 1996 7.8 18.7 1997 50.5 40.6 1998 -5.0 8.1 1999 63.2 39.8 2000 44.1 16.3 2001 -26.4 -24.4 --------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS for periods ended June 30, 2001 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal year. Securities and Exchange Commission rules require that we provide this information. TEN YEARS ONE FIVE ---------------------------- INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL ---------------------------------------------------------------------------------------------- PRIMECAP Fund 11/1/1984 -16.63% 20.71% 18.88% 0.79% 19.67% Fee-Adjusted Returns* -17.46 20.71 18.88 0.79 19.67 ----------------------------------------------------------------------------------------------
*Reflective of the 1% fee assessed on redemptions of shares purchased on or after April 23, 2001, and held for less than five years. **Derived from data provided by Lipper Inc. See Financial Highlights table on page 19 for dividend and capital gains information for the past five years. 12 YOUR FUND'S AFTER-TAX RETURNS This table presents returns for your fund both before and after taxes. The after-tax returns are shown in two ways: (1) assuming that an investor owned the fund during the entire period and paid taxes on the fund's distributions, and (2) assuming that an investor paid taxes on the fund's distributions and sold all shares at the end of each period. Calculations are based on the highest individual federal income tax and capital gains tax rates in effect at the times of the distributions and the hypothetical sales. State and local taxes were not considered. (In the example that assumes all fund shares were sold, a negative pre-tax total return translates into a higher after-tax return. This is because the calculation assumes that the investor received a tax deduction for the loss incurred on the sale.) Please note that your actual after-tax returns will depend on your tax situation and may differ from those shown. Also note that if you own the fund in a tax-deferred account, such as an individual retirement account or a 401(k) plan, this information does not apply to you. Such accounts are not subject to current taxes. Finally, keep in mind that a fund's performance--whether before or after taxes--does not indicate how it will perform in the future. -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED AUGUST 31, 2001 ONE YEAR* FIVE YEARS TEN YEARS ---------------------------------------- PRIMECAP Fund Return Before Taxes -27.13% 19.85% 18.14% Return After Taxes on Distributions -28.25 18.25 16.70 Return After Taxes on Distributions and Sale of Fund Shares -15.63 16.38 15.31 -------------------------------------------------------------------------------- *Reflective of the 1% fee assessed on redemptions of shares purchased on or after April 23, 2001, and held for less than five years. 13 FINANCIAL STATEMENTS AUGUST 31, 2001 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, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. 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 (91.4%) -------------------------------------------------------------------------------- AUTO & TRANSPORTATION (14.1%) *(1) FedEx Corp. 15,896,000 $ 669,222 *(1) AMR Corp. 14,677,800 469,543 (1) Delta Air Lines, Inc. 11,190,800 431,965 Southwest Airlines Co. 19,587,375 350,418 Union Pacific Corp. 5,800,000 308,966 General Motors Corp. 2,632,365 144,122 *(1) Alaska Air Group, Inc. 2,540,000 82,906 UAL Corp. 2,300,000 75,164 (1) Airborne, Inc. 3,400,000 46,104 ArvinMeritor, Inc. 1,800,600 31,871 United Parcel Service, Inc. 495,270 27,354 Fleetwood Enterprises, Inc. 1,238,100 18,324 ------------- 2,655,959 ------------- CONSUMER DISCRETIONARY (13.2%) * General Motors Corp. Class H 29,452,093 549,282 Eastman Kodak Co. 7,710,000 344,406 *(1) Robert Half International, Inc. 10,400,000 258,856 TJX Cos., Inc. 5,467,400 191,906 Lowe's Cos., Inc. 4,908,600 182,600 * Best Buy Co., Inc. 2,685,000 158,361 Target Corp. 3,949,000 136,833 *(1) The Neiman Marcus Group, Inc. Class A 2,455,700 78,116 News Corp. Ltd. ADR 2,472,000 68,598 Carnival Corp. 2,155,000 67,408 The Walt Disney Co. 2,500,000 63,575 * Liberty Media Corp. 4,000,000 60,800 Manpower Inc. 1,829,400 56,382 Washington Post Co. Class B 75,000 43,012 (1) The McClatchy Co. Class A 1,000,000 43,000 * Fox Entertainment Group, Inc. Class A 1,500,000 36,780 RadioShack Corp. 1,500,000 35,100 *(1) The Neiman Marcus Group, Inc. Class B 1,124,511 34,455 Dillard's Inc. 1,241,500 22,223 * Abercrombie & Fitch Co. 700,000 21,238 NIKE, Inc. Class B 400,000 20,000 * AutoZone Inc. 200,000 9,240 Tiffany & Co. 262,000 8,161 Mattel, Inc. 250,000 4,497 The Gap, Inc. 90,000 1,768 * GC Cos. 200,000 102 ------------- 2,496,699 ------------- FINANCIAL SERVICES (3.6%) Torchmark Corp. 2,600,000 109,824 Bank One Corp. 3,049,300 105,780 The Chubb Corp. 1,500,500 101,284 Wells Fargo Co. 2,000,000 92,020 Jefferson-Pilot Corp. 1,500,000 69,780 Transatlantic Holdings, Inc. 843,750 61,889 Lincoln National Corp. 1,000,000 49,860 St. Paul Cos., Inc. 1,100,000 46,233 American International Group, Inc. 463,200 36,222 ------------- 672,892 ------------- 14 -------------------------------------------------------------------------------- MARKET VALUE^ SHARES (000) -------------------------------------------------------------------------------- HEALTH CARE (10.9%) Pharmacia Corp. 21,054,781 $ 833,769 * Guidant Corp. 11,246,264 406,215 Novartis AG ADR 11,061,900 403,427 Medtronic, Inc. 3,465,000 157,796 * Boston Scientific Corp. 5,900,000 112,690 * Biogen, Inc. 1,120,000 67,603 * Applera Corp.-Celera Genomics Group 1,073,600 28,504 * Amgen, Inc. 442,000 28,421 * Chiron Corp. 445,000 20,746 ------------- 2,059,171 ------------- INTEGRATED OILS (3.6%) Phillips Petroleum Co. 7,625,000 438,437 Amerada Hess Corp. 3,090,000 240,124 ------------- 678,561 ------------- OTHER ENERGY (2.4%) Anadarko Petroleum Corp. 5,000,000 258,750 (1) Noble Affiliates, Inc. 3,600,000 121,500 (1) Pogo Producing Co. 3,200,000 76,448 * Aquila, Inc. 200,000 5,210 ------------- 461,908 ------------- MATERIALS & PROCESSING (3.5%) Potash Corp. of Saskatchewan, Inc. 2,600,000 163,358 Engelhard Corp. 5,200,000 135,876 Sigma-Aldrich Corp. 2,500,000 114,025 (1) Granite Construction Co. 3,150,000 76,387 Temple-Inland Inc. 1,300,000 75,868 OM Group, Inc. 1,036,400 67,480 (1) MacDermid, Inc. 1,701,000 28,084 * Syngenta AG ADR 765,768 8,071 ------------- 669,149 ------------- PRODUCER DURABLES (6.6%) Caterpillar, Inc. 5,770,000 288,500 (1) Millipore Corp. 2,820,000 178,929 * Lexmark International, Inc. 3,000,000 156,150 *(1) Tektronix, Inc. 6,629,600 129,542 Deere & Co. 2,448,500 105,702 Pitney Bowes, Inc. 2,400,000 104,376 *(1) Plantronics, Inc. 4,824,000 95,998 Kennametal, Inc. 1,260,000 49,140 * Agilent Technologies, Inc. 1,678,160 44,471 Donaldson Co., Inc. 1,080,000 32,238 * Dionex Corp. 1,020,000 30,518 Pall Corp. 750,000 16,770 Molex, Inc. 244,140 7,708 Molex, Inc. Class A 244,140 6,426 ------------- 1,246,468 ------------- TECHNOLOGY (29.3%) COMMUNICATIONS TECHNOLOGY (4.5%) Motorola, Inc. 21,425,550 372,805 LM Ericsson Telephone Co. ADR Class B 38,488,888 191,675 Nortel Networks Corp. 26,434,600 165,481 * Tellabs, Inc. 6,000,000 79,920 Symbol Technologies, Inc. 3,750,000 50,625 COMPUTER SERVICES SOFTWARE & SYSTEMS (10.7%) (1) Adobe Systems, Inc. 18,960,000 637,246 *(1) Sabre Holdings Corp. 11,968,611 504,836 * Microsoft Corp. 7,910,000 451,265 *(1) Citrix Systems, Inc. 10,300,000 339,385 * Rational Software Corp. 5,995,000 86,088 COMPUTER TECHNOLOGY (1.7%) Hewlett-Packard Co. 10,400,000 241,384 Compaq Computer Corp. 6,500,000 80,275 * Evans & Sutherland Computer Corp. 466,000 3,751 ELECTRONICS (1.4%) Sony Corp. ADR 5,847,400 262,548 ELECTRONICS--SEMICONDUCTORS/COMPONENTS (10.0%) * Micron Technology, Inc. 19,837,000 746,070 Texas Instruments, Inc. 21,514,000 712,113 Intel Corp. 12,750,000 356,490 * Xilinx, Inc. 1,000,000 39,040 * LSI Logic Corp. 1,400,000 28,350 ELECTRONICS TECHNOLOGY (0.3%) *(1) Coherent, Inc. 1,800,000 63,720 SCIENTIFIC EQUIPMENT & SUPPLIES (0.7%) Applera Corp.-Applied Biosystems Group 5,119,000 128,026 ------------- 5,541,093 ------------- UTILITIES (3.0%) (1) UtiliCorp United, Inc. 6,707,200 215,704 Sprint Corp. 8,848,800 206,531 * WorldCom Inc.- WorldCom Group 10,847,800 139,503 * Global Crossing Ltd. 1,650,000 6,979 * WorldCom, Inc.-MCI Group 433,912 5,593 ------------- 574,310 ------------- OTHER (1.2%) 218,745 -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (COST $13,561,138) 17,274,955 -------------------------------------------------------------------------------- 15 -------------------------------------------------------------------------------- FACE MARKET AMOUNT VALUE^ PRIMECAP FUND (000) (000) -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (8.8%) -------------------------------------------------------------------------------- REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 3.67%, 9/4/2001 $1,658,438 $ 1,658,438 3.69%, 9/4/2001--Note G 3,430 3,430 -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (COST $1,661,868) 1,661,868 -------------------------------------------------------------------------------- TOTAL INVESTMENTS (100.2%) (COST $15,223,006) 18,936,823 -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-0.2%) -------------------------------------------------------------------------------- Other Assets--Note C 37,569 Liabilities--Note G (79,955) ------------- (42,386) ------------- -------------------------------------------------------------------------------- NET ASSETS (100%) -------------------------------------------------------------------------------- Applicable to 364,042,397 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $18,894,437 ================================================================================ NET ASSET VALUE PER SHARE $51.90 ================================================================================ ^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 $4,581,946,000. ADR--American Depositary Receipt. -------------------------------------------------------------------------------- AMOUNT PER (000) SHARE -------------------------------------------------------------------------------- AT AUGUST 31, 2001, NET ASSETS CONSISTED OF: -------------------------------------------------------------------------------- Paid-in Capital--Note E $14,704,404 $40.39 Undistributed Net Investment Income--Note E 57,798 .16 Accumulated Net Realized Gains--Note E 418,418 1.15 Unrealized Appreciation-- Note F 3,713,817 10.20 -------------------------------------------------------------------------------- NET ASSETS $18,894,437 $51.90 ================================================================================ 16 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the two most recent reporting periods, and details the operating expenses charged to the fund. These expenses directly reduce the amount of investment income available to pay to shareholders as income 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) of investments during the period. -------------------------------------------------------------------------------- PRIMECAP FUND JAN. 1 TO YEAR ENDED AUG. 31, 2001 DEC. 31, 2000 (000) (000) -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 89,181 $ 114,545 Interest 54,431 163,822 Security Lending 524 3,498 -------------------------------------------------------------------------------- Total Income 144,136 281,865 -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B 24,289 39,304 The Vanguard Group--Note C Management and Administrative 40,641 64,991 Marketing and Distribution 1,836 2,251 Custodian Fees 17 26 Auditing Fees 12 17 Shareholders' Reports 444 393 Trustees' Fees and Expenses 25 28 -------------------------------------------------------------------------------- Total Expenses 67,264 107,010 Expenses Paid Indirectly--Note D (1,254) (1,608) -------------------------------------------------------------------------------- Net Expenses 66,010 105,402 -------------------------------------------------------------------------------- NET INVESTMENT INCOME 78,126 176,463 -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) ON INVESTMENT SECURITIES SOLD* 446,817 1,262,961 -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES (3,468,377) (817,005) -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $(2,943,434) $ 622,419 ================================================================================ *Dividend income and realized net gain (loss) from affiliated companies were $9,161,000 and $85,741,000, respectively, for 2001. 17 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the three 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, JAN. 1 TO -------------------------- AUG. 31, 2001 2000 1999 (000) (000) (000) -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 78,126 $ 176,463 $ 68,663 Realized Net Gain (Loss) 446,817 1,262,961 1,384,850 Change in Unrealized Appreciation (Depreciation) (3,468,377) (817,005) 3,525,163 -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations (2,943,434) 622,419 4,978,676 -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income (7,122) (166,715) (72,408) Realized Capital Gain (138,858) (1,350,981) (1,230,786) -------------------------------------------------------------------------------- Total Distributions (145,980) (1,517,696) (1,303,194) -------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS1 Issued 2,224,102 6,063,577 3,367,477 Issued in Lieu of Cash Distributions 142,896 1,484,196 1,274,413 Redeemed* (2,145,258) (2,802,249) (1,615,394) -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions 221,740 4,745,524 3,026,496 -------------------------------------------------------------------------------- Total Increase (Decrease) (2,867,674) 3,850,247 6,701,978 -------------------------------------------------------------------------------- NET ASSETS Beginning of Period 21,762,111 17,911,864 11,209,886 -------------------------------------------------------------------------------- End of Period $18,894,437 $21,762,111 $17,911,864 ================================================================================ 1Shares Issued (Redeemed) Issued 39,306 89,135 61,046 Issued in Lieu of Cash Distributions 2,660 23,985 21,809 Redeemed (38,352) (41,264) (29,493) -------------------------------------------------------------------------------- Net Increase (Decrease) in Shares Outstanding 3,614 71,856 53,362 ================================================================================ *Net of redemption fees of $120,000 for 2001. 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.
----------------------------------------------------------------------------------------------- VANGUARD PRIMECAP FUND YEAR ENDED DECEMBER 31, JAN. 1, 2001 TO ---------------------------------------------------------------- AUGUST 31, 2001 2000 1999 1998 1997 1996 ----------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $60.38 $62.07 $47.66 $39.56 $30.08 $26.23 ----------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .21 .52 .26 .34 .21 .19 Net Realized and Unrealized Gain (Loss) on Investments (8.28) 2.33 19.07 9.63 10.77 4.59 ----------------------------------------------------------------------------------------------- Total from Investment Operations (8.07) 2.85 19.33 9.97 10.98 4.78 ----------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.02) (.49) (.27) (.35) (.20) (.20) Distributions from Realized Capital (.39) (4.05) (4.65) (1.52) (1.30) (.73) Gains ----------------------------------------------------------------------------------------------- Total Distributions (.41) (4.54) (4.92) (1.87) (1.50) (.93) ----------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $51.90 $60.38 $62.07 $47.66 $39.56 $30.08 =============================================================================================== TOTAL RETURN* -13.39% 4.47% 41.34% 25.44% 39.79% 18.31% =============================================================================================== RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $18,894 $21,762 $17,912 $11,210 $8,186 $4,204 Ratio of Total Expenses to Average Net Assets 0.50%** 0.48% 0.51% 0.51% 0.51% 0.59% Ratio of Net Investment Income to Average Net Assets 0.58%** 0.80% 0.50% 0.78% 0.69% 0.69% Turnover Rate 7% 11% 19% 13% 13% 10% ===============================================================================================
*Total returns do not reflect the 1% fee assessed on redemptions of shares purchased on or after April 23, 2001, and held for less than five years. **Annualized. 19 NOTES TO FINANCIAL STATEMENTS Vanguard PRIMECAP Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. Effective in 2001, the fund's fiscal year-end changed from December 31 to August 31. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. 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. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial statement purposes. 5. OTHER: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. Fees assessed on redemptions of capital shares are credited to paid-in capital. B. PRIMECAP Management Company provides investment advisory services to the fund for a fee calculated at an annual percentage rate of average net assets. For the period ended August 31, 2001, the investment advisory fee represented an effective annual rate of 0.18% 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 August 31, 2001, the fund had contributed capital of $3,702,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 3.7% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. D. The fund has asked its investment adviser to direct certain security 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 management and administrative expenses. The fund's custodian bank has also agreed to reduce its fees when the fund maintains cash on deposit in the non-interest-bearing custody account. For the period ended 20 August 31, 2001, directed brokerage and custodian fee offset arrangements reduced expenses by $1,245,000 and $9,000, respectively. The total expense reduction represented an effective annual rate of 0.01% of the fund's average net assets. E. During the period ended August 31, 2001, the fund purchased $1,973,575,000 of investment securities and sold $1,218,305,000 of investment securities, other than temporary cash investments. The fund used a tax accounting practice to treat a portion of the price of capital shares redeemed during the year as distributions from net investment income and realized capital gains. Accordingly, the fund has reclassified $5,171,000 from undistributed net investment income, and $28,590,000 from accumulated net realized gains, to paid-in capital. F. At August 31, 2001, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $3,713,817,000, consisting of unrealized gains of $5,051,437,000 on securities that had risen in value since their purchase and $1,337,620,000 in unrealized losses on securities that had fallen in value since their purchase. G. The market value of securities on loan to broker/dealers at August 31, 2001, was $3,279,000, for which the fund held cash collateral of $3,430,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. 21 REPORT OF INDEPENDENT ACCOUNTANTS 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 August 31, 2001, and the results of its operations, the changes in its net assets and the financial highlights for each of the periods indicated, in conformity with accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the United States of America, 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 August 31, 2001 by correspondence with the custodian, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Philadelphia, Pennsylvania October 9, 2001 -------------------------------------------------------------------------------- SPECIAL 2001 TAX INFORMATION (UNAUDITED) FOR VANGUARD PRIMECAP FUND This information for the fiscal period ended August 31, 2001, is included pursuant to provisions of the Internal Revenue Code. The fund distributed $156,586,000 as capital gain dividends (from net long-term capital gains) to shareholders during the fiscal period, all of which is designated as a 20% rate gain distribution. For corporate shareholders, 52.8% of investment income (dividend income plus short-term gains, if any) qualifies for the dividends-received deduction. -------------------------------------------------------------------------------- 22 ADVANTAGES OF VANGUARD.COM Why wait for the mail? You can get fund reports like this one sooner--and reduce the amount of mail you receive from us. Simply choose to view your fund reports online. Consider the benefits of using Vanguard.com. On our website, you can: * Choose to receive all fund reports, as well as prospectuses, online. * Request a courtesy e-mail to notify you when a new fund report or prospectus is available. When you receive fund reports and prospectuses online, you lower Vanguard's printing and postage costs--and that helps to reduce the expense ratios of your funds. You will continue to receive confirmations of purchases, redemptions, and other account activity by mail. HOW TO NOTIFY US ABOUT YOUR MAILING PREFERENCES You can easily tell us to stop mailing your fund reports and prospectuses. Just log on to Vanguard.com (or follow the easy steps to register for secure, online access to your accounts) and update your Web profile. Registered users can also view their account values; download records of recent transactions; research and track the performance of individual securities and funds; buy, exchange, and sell fund shares; and much more. If you invest directly with us, you can also elect to receive all of your account statements online or to continue the mailing of only your year-end statements, which detail every transaction you make during the year. However, if you invest with us through an employer-sponsored retirement plan or a financial intermediary, some of these options may not be available to you. All Vanguard shareholders can choose to receive our electronic newsletters: Economic Week in Review, a recap of each week's key economic reports and market activity; and What's New at Vanguard, a monthly update on our mutual funds, services, and online resources. YOUR ONLINE INFORMATION IS SECURE Vanguard.com uses some of the most secure forms of online communication available, including data encryption and Secure Sockets Layer (SSL) protocol. These technologies provide a high level of security and privacy when you access your account information, initiate online transactions, or send us messages. 23 THE VANGUARD(R) FAMILY OF FUNDS STOCK FUNDS 500 Index Fund Calvert Social Index(TM) Fund Capital Opportunity Fund Convertible Securities Fund Developed Markets Index Fund Emerging Markets Stock Index Fund Energy Fund Equity Income Fund European Stock Index Fund Explorer(TM) Fund Extended Market Index Fund Global Equity Fund Growth and Income Fund Growth Equity Fund Growth Index Fund Health Care Fund Institutional Developed Markets Index Fund Institutional Index Fund Institutional Total Stock Market Index Fund International Growth Fund International Value Fund Mid-Cap Index Fund Morgan(TM) Growth Fund Pacific Stock Index Fund Precious Metals Fund PRIMECAP Fund REIT Index Fund Selected Value Fund Small-Cap Growth Index Fund Small-Cap Index Fund Small-Cap Value Index Fund Strategic Equity Fund Tax-Managed Capital Appreciation Fund Tax-Managed Growth and Income Fund Tax-Managed International Fund Tax-Managed Small-Cap Fund Total International Stock Index Fund Total Stock Market Index Fund U.S. Growth Fund U.S. Value Fund Utilities Income Fund Value Index Fund Windsor(TM) Fund Windsor(TM) II Fund BALANCED FUNDS Asset Allocation Fund Balanced Index Fund LifeStrategy(R) Conservative Growth Fund LifeStrategy(R) Growth Fund LifeStrategy(R) Income Fund LifeStrategy(R) Moderate Growth Fund STAR(TM) Fund Tax-Managed Balanced Fund Wellesley(R) Income Fund Wellington(TM) Fund BOND FUNDS GNMA Fund High-Yield Corporate Fund High-Yield Tax-Exempt Fund Inflation-Protected Securities Fund Insured Long-Term Tax-Exempt Fund Intermediate-Term Bond Index Fund Intermediate-Term Corporate Fund Intermediate-Term Tax-Exempt Fund Intermediate-Term Treasury Fund Limited-Term Tax-Exempt Fund Long-Term Bond Index Fund Long-Term Corporate Fund Long-Term Tax-Exempt Fund Long-Term Treasury Fund Short-Term Bond Index Fund Short-Term Corporate Fund Short-Term Federal Fund Short-Term Tax-Exempt Fund Short-Term Treasury Fund State Tax-Exempt Bond Funds (California, Florida, Massachusetts, New Jersey, New York, Ohio, Pennsylvania) Total Bond Market Index Fund MONEY MARKET FUNDS Admiral(TM) Treasury Money Market Fund Federal Money Market Fund Prime Money Market Fund State Tax-Exempt Money Market Funds (California, New Jersey, New York, Ohio, Pennsylvania) Tax-Exempt Money Market Fund Treasury Money Market Fund VARIABLE ANNUITY PLAN Balanced Portfolio Diversified Value Portfolio Equity Income Portfolio Equity Index Portfolio Growth Portfolio High-Grade Bond Portfolio High Yield Bond Portfolio International Portfolio Mid-Cap Index Portfolio Money Market Portfolio REIT Index Portfolio Short-Term Corporate Portfolio Small Company Growth Portfolio For information about Vanguard funds and our variable annuity plan, including charges and expenses, obtain a prospectus from The Vanguard Group, P.O. Box 2600, Valley Forge, PA 19482-2600. Read it carefully before you invest or send money. -------------------------------------------------------------------------------- THE PEOPLE WHO GOVERN YOUR FUND The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, which is owned by the funds and exists solely to provide services to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. They bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members' responsibilities are selecting investment advisers for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new trustees/ directors; and electing Vanguard officers. The list below provides a brief description of each trustee's professional affiliations. The year in which the trustee joined the Vanguard board is noted in parentheses. -------------------------------------------------------------------------------- TRUSTEES JOHN J. BRENNAN (1987) Chairman of the Board, Chief Executive Officer, and Director/Trustee of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. CHARLES D. ELLIS (2001) Senior Adviser to Greenwich Associates; Successor Trustee of Yale University; Overseer of the Stern School of Business at New York University; Trustee of the Whitehead Institute for Biomedical Research. JOANN HEFFERNAN HEISEN (1998) Vice President, Chief Information Officer, and a member of the Executive Committee of Johnson & Johnson; Director of The Medical Center at Princeton, and Women's Research and Education Institute. BRUCE K. MACLAURY (1990) President Emeritus of The Brookings Institution; Director of American Express Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp. BURTON G. MALKIEL (1977) Chemical Bank Chairman's Professor of Economics, Princeton University; Director of Prudential Insurance Co. of America, BKF Capital, The Jeffrey Co., and NeuVis, Inc. ALFRED M. RANKIN, JR. (1993) Chairman, President, Chief Executive Officer, and Director of NACCO Industries, Inc.; Director of Goodrich Corp. JAMES O. WELCH, JR. (1971) Retired Chairman of Nabisco Brands, Inc. (Food Products); retired Vice Chairman and Director of RJR Nabisco (Food and Tobacco Products); Director of TECO Energy, Inc. J. LAWRENCE WILSON (1985) Retired Chairman and Chief Executive Officer of Rohm and Haas Co.; Director of AmeriSource Health Corporation, Cummins Inc., and The Mead Corp.; Trustee of Vanderbilt University. -------------------------------------------------------------------------------- OTHER FUND OFFICERS R. GREGORY BARTON, Secretary; Managing Director- Legal and Secretary of The Vanguard Group, Inc.; Secretary of each of the investment companies in The Vanguard Group. THOMAS J. HIGGINS, Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies in The Vanguard Group. -------------------------------------------------------------------------------- VANGUARD MANAGING DIRECTORS JAMES H. GATELY, Direct Investor Services. KATHLEEN C. GUBANICH, Human Resources. IAN A. MACKINNON, Fixed Income Group. F. WILLIAM MCNABB, III, Institutional Investor Group. MICHAEL S. MILLER, Planning and Development. RALPH K. PACKARD, Chief Financial Officer. GEORGE U. SAUTER, Quantitative Equity Group. -------------------------------------------------------------------------------- JOHN C. BOGLE Founder; Chairman and Chief Executive, 1974-1996. [THE VANGUARD GROUP(R) LOGO] Post Office Box 2600 Valley Forge, PA 19482-2600 ABOUT OUR COVER Our cover photograph was taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photograph is copyrighted by Mr. Kahn. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. Standard & Poor's(R), S&P(R), S&P 500(R), Standard & Poor's 500, 500, S&P MidCap 400, and S&P SmallCap 600 are trademarks of The McGraw-Hill Companies, Inc. All other index names may contain trademarks and are the exclusive property of their respective owners. WORLD WIDE WEB www.vanguard.com FUND INFORMATION 1-800-662-7447 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. (C)2001 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q590 102001