Re: I just purchased a 40 HP Nissan.
... since this 40HP has power trim and oiling it must be a 3 cylinder 40D, not the 2 cylinder 40C, so the no. 2 cylinder is in the middle, and he says the reeds look good, so...
get a good compression tester. crank it to a stop with each cylinder near TDC (one at a time) and find out how many PSI you lose in 10 or 30 seconds. If they are all the same, its the head gasket, the cylinder, the piston, or the rings. Carbon build up can make the rings stick and tank the compression, so do a carbon remover treatment, use SeaFoam, unless you like waiting overnight better. If that didn't fix it, when you remove the head to look, you'll end up installing a new gasket, so you have that covered. If you see anything that gets your attention you can very lightly hone the cylinder and see if the rings will re-seat. You might have a cracked ring, which would be some work to replace.
If the rate of pressure loss was the nearly the same for all three cylinders, then the problem is in the crankcase. 2 stroke motors use the back side of the cylinder to draw in and pre-compress the air-fuel charge, so any leaks there can spoil the compression. Bubble solution is an effective diagnostic tool...