From PHOTOXELS tutorial about ISO:
ISO Speed & Noise
However, all this increase in sensitivity does not come free. There is a price to pay with your image appearing more noisy.
See, when you boost the sensitivity of your image sensor by selecting a higher ISO, the image sensor is now able to record a fainter light signal. However, it is also true now that it will record fainter noise, where noise is any signal that is not attributed to the light from your subject. Remember that an image sensor is still an analog device and it generates its own noise, too! The increased sensitivity allows the image sensor to record more light signal and more noise. The ratio of light signal to noise (S/N ratio) determines the "noise" in your resultant image.
An image sensor is usually calibrated so that it gives the best image quality (greatest S/N ratio) at its lowest possible ISO speed. For most consumer digital cameras, this value will be expressed as ISO 50, ISO 64 or ISO 100. A few digital cameras use ISO 200 as their lowest ISO speed.
Just as with its film counterpart, an image sensor will exhibit "noise" (comparable to "graininess" in film) at the higher ISO speeds. Unlike film, where graininess can sometimes contribute to the mood of the image, noise produced by an image sensor is undesirable and appears as a motley of distracting coloured dots on your image.
ISO Speed & Image Sensor Size
The size of the image sensor determines the ISO speed range that a digital camera can use without suffering from undue noise. One reason for this is because the pixels on the larger image sensor can be larger and therefore receive more light, and thus have a greater signal-to-noise (S/N) ratio (for more information on noise, see our tutorial: What Is... Noise?).
If we take two image sensors, each with 4 megapixels resolution, but of different sizes, the 4 megapixels image sensor that is smaller will exhibit more noise at higher ISOs than the larger one.
1/1.8 in. (7.2x5.3mm)
APS-sized (23x15mm)
4 million tiny pixels crammed into a 1/1.8 in. image sensor cannot compete in image quality with 4 million large pixels on an APS-sized image sensor.
Most consumer digital cameras use 1/1.8 in. (and smaller) image sensors, so noise at high ISO is a problem. Though they will allow you to use a high ISO (such as ISO 400), the resultant image will usually be very noisy.
A digital SLR (dSLR), on the other hand, uses a large image sensor, usually full frame (24x36 mm) or APS-sized (half-frame). Noise is rarely a problem and the use of a high ISO 400 results in images with barely noticeable noise.
Practical Considerations
You obtain the best image quality by using the lowest ISO possible on your digital camera. If you want to ensure your digital camera always uses the lowest ISO setting, switch the ISO setting from the default "Auto ISO" (this setting is usually found in the Menu) to the lowest possible on the camera, say ISO 50.
If you mostly take pictures where there is enough light for a correct exposure, i.e. sunny outdoors, then using the lowest ISO on your digital camera will give you the best image quality your digital camera is capable of.
If you want to take pictures indoors where light may not be sufficient and in other low-light situations, then you would need to supplement existing light with flash or studio lights. Either that, or select a higher ISO. Of course, depending on your digital camera, a higher ISO may mean a noisy image.
A large image sensor (APS-sized and larger) means that you are able to use a high ISO speed without unduly worrying about noise. This means that you can take pictures in low-light situations without your pictures being under-exposed. It also means that in situations where it is required, you are able to use a fast enough shutter speed to prevent camera shake. All without noise.