Water-soluble pencils are versatile cross-over between drawing and painting as the moment you introduce water, the color disperses and you've got paint. I find them particularly useful for sketching, for planning a composition on a canvas, and for traveling. (Though this by no means is the end of their versatility!)
There are numerous brands available, so which are the best? Here are my personal favorites from the brands of water-soluble pencil and crayons I've tried, in order of preference.

Image ©2007 Marion Boddy-EvansThese are short, water soluble wax crayons, available either in tin sets or individually at some art supply stores in 48 colors. They're about half the length of a 'normal' pencil (about 90mm long and 10 mm in diameter), with labels designed to be peeled off in sections. Lyra are manufactured in Germany.
I like these water-soluble crayons best of all the brands I've tried because they're soft and glide smoothly across a surface, so it's easy to get a lot of color down. The colors are intense and easily convert into paint when you add water. The only downside is that it's hard to draw a fine line with them, rather pick up some color with a brush instead.
Don't leave them lying in the sun or dash of a car or they
will melt!

Image ©2007 Marion Boddy-EvansThese water soluble wax crayons are similar to Lyra's, but a bit harder. Size wise they're narrower and longer -- about 105mm long and 6mm in diameter. (I haven't yet melted a Lyra and Caran d'Ache to to compare if you're getting the same quantity of crayon overall.) Manufactured in Switzerland.
Again the paper label is designed to be torn off in sections and you shouldn't leave them lying around in a hot spot or they'll melt. Available in 84 colors.

Image ©2007 Marion Boddy-EvansWoodless pencils, just the 'lead' covered with a wrapper, which means they never need sharpening. They're of medium hardness, so it's fairly easy to get a fine line and to put down a good quantity of color or only a little if you don't press hard.
I often use these for sketching a composition on a canvas, using a color I know will be in my initial blocking in. When I start painting, I "dissolve" the sketch into the paint.

Image ©2007 Marion Boddy-EvansAs the name suggests, these water-soluble pencils produce ink rather than watercolor paint. The colors produced are transparent and, is permanent. Inktense pencil can be worked over with a dry or wet medium. Available in 24 colors, including white.

Image ©2007 Marion Boddy-EvansI've got an old set of these (bought nearly 10 years ago) and haven't used them much as I found them too hard to get much color down easily. But it's more a question of my not working in colored pencil often enough and forgetting I mustn't expect them to put down color like a crayon. Derwent have updated and upgraded their watercolor pencils since the set I bought (shown in the photo).