I have a 500gig external drive for my desktop computer which, at first, was meant to be for documents, back-ups, that kinda stuff, but it now holds my Steam folder and all the games in it.
It has games like Team Fortress 2, Left 4 Dead, Half-Life 2 and the episodes, Dawn of War 2, FEAR 2, Civ IV, Call of Duty: WaW, all of which work perfectly well. Ok so the load times are a tiny bit slower than if they were installed on my main drive and I drop into a game of L4D a bit slower than my teammates, but the delay is never that noticable and it never causes any problems. I've never even noticed any lag or framerate drops in the games either.
I guess it depends what games you want to install on it - older games would take little time to load anyway and the external drive would be fine for playing them, whereas the newer, most resource intensive titles would no doubt be best installed on your main drive, which is what I do for every game but those installed through Steam because I'm lazy and can't be bothered to re-download and install on my main drive
If you have an external drive or plan on getting one for reasons other than to install games onto, I say give it a go, theres no harm in trying, but don't purposely buy a drive purely to put your games on because it may not work out how you want and you don't want to have wasted cash on it.