I hope the relevant people notice this bug report soon, it's serious.
Failure to respect /etc/hosts removes a powerful way to manage networks
and also to block ads and some types of web threats.

You can disable dnsmasq by commenting it out in the NetworkManager
config, as the OP said, but there is also a hacky way to let run dnsmasq
but remove the --no-hosts option: wrap dnsmasq in a shell script that
passes all parameters except that one to the original binary.

This answer was found at http://askubuntu.com/questions/117899
/configure-dnsmasq-to-use-etc-hosts-file which helpfully linked back to
this bug.

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https://bugs.launchpad.net/bugs/993298

Title:
  NetworkManager does not use local hosts configuration any more

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