Responding to a reviewer who misunderstood key concepts of a paper

This comment completely misrepresent the methodology described in the paper.

While it may be technically correct, it is unnecessarily undiplomatic (at least all by itself), as it implicitly places blame on the reviewer for not correctly understanding your paper. Again, if the respective points were made unmistakably clear in the paper (which is something that you can easily overestimate), this blame may be justified, but still you risk unnecessarily disgruntling the reviewer.

I would suggest to assume in good faith that the reviewer did not fail to understand your paper due to incompetence or laziness, but because you failed to clarify a certain aspects. Try to improve your paper regarding the explanation of everything that the reviewer misunderstood and reply with something along the lines of:

This comment seems to be based on the assumption that we were proposing a method to transmogrify apples. However, the goal of our method is the transmogrification of bananas – an aspect, which we have failed to make sufficiently clear. We have amended our manuscript accordingly and now write: […]

Do not worry, if the respective revision turns out to be only minor.

To be prepared if the reviewer insists on his or her misunderstandings, I suggest to explicitly state in your response letter that something different is the case. This way you hopefully have some good argument for the editor in this case.

^{I once had a similar experience with a reviewer who criticised that we made several claims which were not supported by our studies. However, we never made any of these claims. In a first revision we reformulated a few sentences that the reviewer had presumably misunderstood and explicitly stated in the response letter that we did not make those claims. The reviewer criticised again that some of the same claims were unsupported. We responded again that we never made those claims and reformulated a handful of sentences. Then either the reviewer finally understood or the editor was fed up with this and the paper was accepted. In both cases, major revisions were requested.}

No one ever seems to talk about this but sometimes... reviewers are terrible.

Not terrible like "Ugh they made me revise my paper" but terrible like "Did this person even read the paper?" I once had a paper where a reviewer made lengthy complaints about the terrible user studies and lack of clarity in user studies for an object. There were no user studies in our paper, there were several clear statements about how there were no user studies in the paper, the 'future work' section detailed the user study collaborations. It was a paper on the method of integrating physical and automated controls, not a paper on user studies. One of the reviewers just... lost the plot. I don't know if they read a different paper, I don't know if they wanted a different paper. The other two reviewers made some excellent revision suggestions which we followed.

It wasn't the first time either. I can't speak for all fields or conferences, of course, but sometimes you just get a terrible review. Terrible not negative, terrible as in makes no sense. Sometimes you respond, sometimes you try to work it in and sometimes you just politely ignore the bits that make no sense. Some fields lend themselves to a wide variety of subject matter experts. Consider, for a moment, robotics. A submission to a robotics conference or journal could be about the mechanical engineering aspect, the automation(AI and Machine Learning) aspects, optimization, computer vision, sensor integration... No single person is going to be an expert in all of these things and some of the most interesting, to me, projects involve some blending of these subjects. It can be hard, then, to find a reviewer from the pool who best fits a submission.

This is the case in many subfields in Computer Science, this may be the case in the field you are working in. When you're talking about research on the bleeding edge sometimes you're talking about stuff that has a limited or restricted audience and, thus, a limited or restricted reviewer pool. There are a fair amount of similar questions about academic research reviewers and reviews here. Typically the benefit of the doubt is given that the reviewer is bringing up legitimate complaints and, to be honest, that is the best policy for everyone to have. But sometimes it's ok to accept that a reviewer is totally out there and the review is unhelpful or inappropriate(in that it does not apply.) In those cases I would respond to the other reviews as appropriate and respond, tactfully, to the review in question with statements directly reflecting how the review does not apply to your work.