I don't think the iPad 3 would handle 1080p flawlessly, but trials show it can take on moderately subtitled files at 720p. From a personal standpoint, I do conversions on the grounds of space economy rather than anything motivated by performance.
That said, I don't think the iOS devices should be considered as 'small plastic toys'. They are reasonable forms of technologies used for a specific purpose, and older models simply lack the hardware to run processes that are now more common, such as playing back the latest and greatest videos
