Is it possible to play PSP ISOs from the PSP memory stick?

Yep. Once you install a custom firmware, you just need to put the *.iso file in an "ISO" folder at the root of the memory stick.

You can launch the games from the PSP's official XMB menu after that.

And don't forget to compress them with a program like Daxter, so you have less space used in your memory stick

I don't think the most recent CFWs even support DAX (.dax) compressed ISOs. CSO (.cso) is where it's at, and where it's been at for a while now.