From the Adobe Site:
Smart Objects are layers that contain image data from raster or vector images, such as Photoshop or Illustrator files. Smart Objects preserve an images source content with all its original characteristics, enabling you to perform nondestructive editing to the layer.
You can create Smart objects using several methods: by using the Open As Smart Object command; placing a file, pasting data from Illustrator; or converting one or more Photoshop layers to Smart Objects.
With Smart Objects, you can:
Perform nondestructive transforms. You can scale, rotate, or warp a layer without losing original image data or quality because the transforms dont affect the original data. (Some transform options, such as Perspective and Distort, arent available.)
Work with vector data, such as vector artwork from Illustrator, that otherwise would be rasterized in Photoshop.
Perform nondestructive filtering. You can edit filters applied to Smart Objects at any time.
Edit one Smart Object and automatically update all its linked instances.
You cant perform operations that alter pixel datasuch as painting, dodging, burning, or cloningdirectly to a Smart Object layer, unless it is first converted into a regular layer, which will be rasterized. To perform operations that alter pixel data, you can edit the contents of a Smart Object, clone a new layer above the Smart Object layer, edit duplicates of the Smart Object, or create a new layer.