There are many existing Linux distros. See Distro Watch

But there is always a reason to build your own... e.g. size, appearance, installed software, running services

You can build a distro from scratch using source code, or base it on an existing distro

The book Linux from Scratch shows how to build a Linux system from source code

Advantages: you control exactly what goes into the system; you can make it small; you can use the latest versions of each piece of software

Disadvantages: time consuming; requires lots of knowledge

There are several distros that build from source code, such as Gentoo and Source Mage

They use a package management system, such as Portage for Gentoo

Requires compilation of each package, so takes time

Build instructions at http://www.gentoo.org/doc/en/handbook/handbook-x86.xml

You need to download the Gentoo stage 3 files

The package management system is called portage: you need to download and install it too

Decide which packages you want to include by setting a parameter in /etc/make.conf e.g.

USE="gnome firefox mplayer gstreamer"
	    

You update the packages and install kernel sources

Configure the kernel and build the kernel

Build the packages

Setup boot, networking, etc

There are several tools which take standard distros such as Fedora and allow you to customise them to a new distro

Suse Studio shows how to build a distro based on Suse Linux

Build Your Own Linux Distro is a good walkthrough