DVD to iPod touch (iTunes)?

The best, or, most commonly used method for transcoding DVDs and DivX files to an iPod would be Handbrake. Handbrake has presets for almost all current iDevices. I'd start by reading the Handbrake Mac GUI Guide and selecting iPod Touch from the destination presets (image on Stage 2 from the guide) and adjusting select a target bit rate of 700ish for a device with that small of a screen.

If you're interested in scripting out the process to save time Handbrake has a great CLI and guide that would streamline the process.

Another popular solution would be MacTheRipper.

I don't think iTunes has any facility to automatically re-encode video files as they sync. You'll need to keep two copies on hand: your originals on DVD or in DivX format, and another (smaller) copy in H.264 format. (There are other video codecs that will work, but as long as this is specific for your touch, you might as well use the codec that'll take up the least space.)

To rip DVDs: Handbrake with VLC if needed (violating copyright law is bad, but I'm not your mother, so I don't care) To re-encode the video, you might as well use Handbrake as long as you've got it sitting around.

Media Converter

Free, open source and as lean as it gets. You select the target device, drag your media on to it, and it goes to town. Not a lot of options to get in the way and the defaults are what most people want, most of the time. They even have shareable presets so if you hit upon a particularly nice combination you can pass it along, and vice versa.