Link corrected. ;-)

Drupal page wrote:

The version number indicates the version of Drupal core the contribution is compatible with, whether it is a stable or development release, and what specific "patch level" of the code it represents. These numbers have the form:

CoreCompatibility-Major.PatchLevel[-Extra]

    * CoreCompatibility is required, and will be something like "4.7.x", or "5.x", to indicate what version of Drupal core this contribution is compatible with. Since the API for Drupal core does not change among stable releases, a module that is compatible with Drupal core 4.7.1 would also work with 4.7.3. This is why the version strings for contributions contain the character 'x' to show that they are compatible with any core release ("4.7.x") not just a specific version of core ("4.7.1").
    * Major is the major revision number, which indicates what set of functionality a given release has, if it is stable (bug-fixes only) or development (new features), and so on. The default branch for a given release of core (for example, the "DRUPAL-4-7" branch) will be major version 1. By convention, this major revision should always remain stable, and only security patches and bug fixes should be added to it. Optionally, project maintainers could create additional branches, which would have higher major versions (2, 3, etc.). These additional major revisions will be for whatever the maintainer of the project sees fit. It is up to the project maintainer to document on their project node and in their releases how they're using their own branches and what users of their modules should expect from any available major revision numbers. By convention, if the maintainer is adding new features to a module, they would use major revision 2 or higher.
    * PatchLevel is for a specific release of a given major revision. The first release would be patch level 0. As bugs are fixed, each new releases would have a higher patch level number. If the patch level is the letter "x", it indicates a development snapshot (see [-Extra] immediately below for more information).
    * [-Extra] is optional, and is for specifying things like "-dev", to indicate a development snapshot from the end of a CVS branch (as opposed to an official release from a CVS tag). These snapshots, by their nature, include changing code. It is therefore hard to know exactly what revisions of each file they contain, and this makes them more difficult to debug. Development snapshots also use "x" for the patch level to further indicate the variable nature of the code they contain.

Versions with extra tend to be less stable (development snapshots in particular are inherently unstable) so they should be avoided for production sites. Official releases uniquely identify an exact set of revisions of each file in a contribution. This identifier can be used in many places: the issue queue, the CVS repository, in forum posts, emails, and so on.

Some example version strings and what they mean should help clarify:

    * 4.7.x-1.0 The initial (patch-level 0) stable release (major revision 1) of a module compatible with any version of Drupal core 4.7.*.
    * 4.7.x-2.1 An updated (patch-level 1) new-feature release (major revision 2) of a module compatible with any version of Drupal core 4.7.*.
    * 5.x-1.0-dev A nightly development snapshot ("-dev") of a stable release (major revision 1) of a module compatible with any version of Drupal core 5.*.