40 HP) Merc

I have a 1994 Merc 2 cycle 40 hp. As I was winterizing it last year i noticed a trickle of water that looked like it was coming from somewhere around the top plug. I pulled it out today , started it up ,and sure enough there is a trickle of water. I pulled the plug and there is water coming out of the cylinder, running. Did a compression test with my ancient tested and all cylinders are 100 lb plus, and consistent in all four. The thing appears to run fine, starts ok. Any ideas as to why? Could it be a head gasket? Haven't ever worked on outboards only cars and many years ago.

Sure sounds like it.

My experience with Mercs is limited. That being said, I don't think your engine has a cylinder head. I believe there is a water-jacket cover with a gasket that can leak and do exactly as you describe. Your problem may be much less than you imagined at first. Replacing the cover gasket will appear to be easy until you snap the first bolt off. Proceed carefully to avoid snapping any bolts off.

Looks like I'm going to need a repair manual, recommendations?

Factory book, always use the factory book. Best place to buy is probably ebay. Maybe your local dealer has one.