Excerpts from mvps.org:
You can use a HOSTS file to block ads, banners, 3rd party Cookies, 3rd party page counters, web bugs, and even most hijackers. This is accomplished by blocking the connection(s) that supplies these little gems.
In many cases using a well designed HOSTS file can speed the loading of web pages by not having to wait for these ads, annoying banners, hit counters, etc. to load. This also helps to protect your Privacy and Security by blocking sites that may track your viewing habits, also known as "click-thru tracking" or Data Miners. Simply using a HOSTS file is not a cure-all against all the dangers on the Internet, but it does provide another very effective "Layer of Protection".

Another great feature of the HOSTS file is that it is a two-way file, meaning if some parasite does get into your system (usually bundled with other products) the culprit can not get out (call home) as long as the necessary entries exist. This is why it's important to keep your HOSTS file up to Date.

Modifying Hosts file for XP

Modifying Hosts file for Vista