ISO measures the raw power of a hitter by taking only extra-base hits -- and the type of extra-base hit -- into account.
For example, a player who goes 1-for-5 with a double has an ISO of .200. A player who goes 2-for-5 with a single and a double has a higher batting average than the first player, but the same ISO of .200.
(1x2B + 2x3B + 3xHR) / At-bats OR Slugging percentage - Batting average
Why it's useful
By focusing strictly on extra-base hits, ISO can help evaluate the raw power a player has, which, of course, is valuable because extra-base hits tend to have a big impact on who wins games.
The home run and ISO leaderboards correlate strongly. If a player produces a high ISO, he is likelier to contribute in the homer and extra-base hit departments.