Fixed so it's a link. This is better than coming out of the headphone jack at the top of the iPod, but not because it bypasses the internal DAC. Rather, it bypasses the internal volume control, which is the source of considerable sound degradation from an iPod/iPhone.
And joshjp is certainly correct about the impact of how the music is stored. If possible, store the music uncompressed. If you can't hold enough that way, go for lossless compression. And if, heaven forbid, you have to use lossy compression, keep the bit rate at 256 kbps or higher if at all possible. MP3s at less than 256 kbps might as well go through the volume control, not worth much other than background music at that point.
All IMHBCO (in my humble but correct opinion) of course.