I've been trying to find this on the Blender Wiki, but I can't seem to find the details. I knew how to do it one time but I forgot how to do so now.
How do you generate vertex groups for individual bones in an armature automatically?
If you first select the mesh and then the armature and use Ctrl + P > Armature Deform > With Automatic Weights, this will generate a vertex group for the part of the mesh that corresponds to the bone in the armature. (this is dependent on how many bones are in the armature and or how much geometry the mesh has)
You can then use either Edit or Weight Paint mode to tweak what parts of your mesh are affected by each group, to quickly select a group and see the selection, you can go to the Vertex Groups panel in the Object Data tab.
Additionally, you can also parent the mesh to the armature as empty groups..
and then select the bone while in Pose Mode, open the Specials menu with W or from the weight paint view header and choose Assign Automatic from Bones, this can give you a bit more control over how your groups are created as you can see it on the fly and edit it further.
From the Release Logs:
A new method to create vertex weights for bone deformation was added, next to the existing method based on envelopes. The new bone heat method often generates better results, and does not require setting a radius for bones.
It can be used when parenting a mesh to an armature by selecting "Create From Bone Heat" from the available options. After parenting or adding an armature modifier, it can also be used in the combined weight paint and pose mode, using the W key, and choosing "Apply Bone Heat to Vertex Groups".
This features have since been renamed in the menus "With Automatic Weights" and "Assign Automatic from Bones" respectively.