This compares the VM against each host's total capacity, not what is currently free, and applies in addition to the candidate list and to both "Least loaded" and "DRS" modes. Leave it off if your site deliberately oversubscribes (swap, hyperthreads, ...), so that a VM larger than a single host's physical resources is still allowed to be placed.
If no candidate host satisfies it, a message is logged and placement is left to vCenter, as when no usable candidate host exists at all. It has no effect when an explicit host is given.
This is the default for every template and build step using this cloud; each of them can override it either way ("Yes"/"No"), or leave it on "inherit".