Hi,
I use a composite cable (mainly because it is a more common connection) on a 42" LCD and the quality is great, this TV does have component connection and the quality would be better using a component cable, but not all my tv's have component connectivity, so decided against it!
As for the video, well, it gets quite complicated the more you read into it. Basically, 640x480 refers is the maximum resolution of the video that your ipod can handle, not the size of video it will display. Your ipod will display full screen on your TV regardless of the resolution of the video, it just enlarges the video by stretching the image to fit the screen. Obviously the smaller the resolution of the video, the more your ipod needs to stretch the video to display it full screen, increasing blur. So if you intend to watch your movies from your ipod on a big TV, then go for the biggest resolution you can (640x480). If you only intend to watch movies on your ipod, then you need go no bigger than 320x240, the size of the actual ipod screen.
Just for information, the resolution of video that is stored on standard DVDs is usually 720x480, but the effective (displayed) resolution is slightly different depending on the aspect ratio of the movie and the display your using... the more information you look for on things like resolution and aspect ratio, the more complex it gets. I don't understand it all!
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To convert any other type of movie, such as avi's then i use iSquint (Mac) or Videora (Windows) with pretty much the same settings. Videora is free, so it has some advertising incorporated, but don't let that put you off. It uses ffmpeg to encode, which IMO is the best encoder available.
Please also note that encoding video is a very CPU intensive task, and it take a while. If i'm encoding a dvd or video then i disconnect from the internet and stop all running programs. On a PC that would include spyware detection, virus guard and firewalls (you don't really need them if your not on the net). This will make 100% of your CPU available, which will be used for the duration of the task.
Hopefully this is a fairly understandable crash course to videos on your ipod.
Note: Obviously this information is only for making legitimate copies of media that you either own or that is free of copyright. 😉