At ilounge.com there's an useful article explaining the best ways to get the perfect image of videos on the iPod. You can clearly see the difference, just look at the previous image.

The article talks about "picking the right format and resolution for your videos" which is not easy and the choices end up with two codecs: MPEG-4 or H.264.

While MPEG-4 is by far more "famous" and has some history behind it, the H.264 is kind of new and owned by Apple (it was released with QuickTime7). Both are good in their own ways.

I will go straight to the conclusion:

• "MPEG-4 is likely to be your format of choice if you would like to display high-quality converted widescreen DVD videos from your iPod onto a high-quality television. You'll pick a resolution with 480 or 720 pixels and encode, with superior results on a TV screen"
• For iPod viewing only, H.264 is the wiser choice

Detailed information with more images comparing both formats and different resolutions at The Complete Guide to iPod Video Formats and Display Resolutions from ilounge.com