Water damage to sheet-rock and drywall is especially frustrating because, while it can be repaired, the cost to do so is often more expensive than the cost to replace it. Swelling and staining are common sins of water damage. If the drywall has been painted stains may not be readily apparent but will show through over time. Re-painting over damaged areas will not solve the problem.
Drywall and sheet-rock can usually be cut in a horizontal fashion, somewhere above the level of the damage and removed. You can replace it with an undamaged piece, prepare it and paint it. If you are less of a handy man and aren’t sure you can successfully hide the seam., then replace the whole piece. Either way, the end result will look much better than trying to patch it with a temporary fix.
Be sure that the wall cavity is dry and water free. Leaving water unattended in any area like this can make it a prime candidate for mold. Any water damaged insulation should be removed and replaced. Always avoid touching any moldy drywall. If you notice a mold growth, have a professional remove it for you. Be sure to wear a face mask when working around drywall products to prevent inhalation of dust chemicals, or other potentially harmful agents.