Cutout CDs and LPs are identical to the factory fresh product produced by the label, with one, and only one, difference: there is a cutout hole or sawmark somewhere on the item, hence the name.
These marks are put on the product (by the distributor typically) when an item is no longer in print. Once deleted and "cutout" it can no longer be returned to the distributor or label for credit, which is the reason for marking it. The mark has nothing to do with the quality of the product, only its status as overstock or deleted. The mark does not affect the playing quality of the item in any way.
Cutout marks are also used to signify a Promotional Copy. "Promo" copies are usually given away, and therefore are marked so as not to be returnable either to the label or distributor for credit.