Watson quickly realizes that Holmes is the man greeting him. Watson wonders how the detective found the hut, and why was he hiding on the moor. Holmes explains that he saw Watson's brand of cigarette stubbed out near the hut. As for Holmes' presence in the hut, on the moor, in Devonshire, the detective explains that he hid so the enemies would not know of his direct involvement. Holmes lied to Watson, he says, so that no one would discover him, should Watson decide to compare notes or bring his master some food. Suddenly upset that his reports went to waste, Watson learns that Holmes actually had them forwarded and has kept them close at hand.
While recounting the day's visit to Coombe Tracey, Watson learns from Holmes that Laura and Mr. Stapleton share a close relationship and that Beryl, the woman masquerading as Stapleton's sister is actually his wife. Shocked at these revelations, the doubting Watson demands proof, and Holmes tells of his own investigation into Stapleton's past, and his career as a schoolmaster up north. Stapleton, it becomes clear, is the enemy they have been after, and he has been using his wife-cum-sister to get at Sir Henry and Laura Lyons. He seduced Lyons and used her to lure Charles onto the moor.
Watson and Holmes decide to visit Laura Lyons again, to tell her of Stapleton's ruse and hopefully, to shift her loyalties. Meanwhile, a sudden scream is heard on the moor, and, upon investigation, they discover the body of Sir Henry or what appears to be a body in his clothes. As it turns out, Barrymore delivered a bunch of old clothes to the convict. The hound had sniffed Henry's stolen boot back in London and had attacked the right clothes on the wrong man. Just then, Stapleton shows up, assuming that the dead man is Henry. When he discovers the truth, he stammers: "Who-who's this?" When Watson wonders why the naturalist assumed it was Sir Henry, Stapleton admits it was because he had asked him to come over. Holmes defuses the situation by suggesting that the convict, Selden, must have just fallen and broken his neck, and goes on to tell Stapleton he intends to go home tomorrow, since he is not interested in the myths that plague the particular case. Suspicious but reassured, Stapleton goes home and the detectives head for the Hall.
Walking and talking on their way home, Watson and Holmes marvel at the self- control of their enemy, who held his tongue even after it became clear his hound had killed the wrong man. They wonder, now that the villain has seen Holmes, whether he will become more cautious or more desperate. Watson suggests that they arrest him at once, but Holmes reminds him that they have yet to establish the proof they need for a conviction.
Holmes has hope for tomorrow's interview with Lyons, but he also claims to have another plan in the works. He tells Watson not to tell Henry of Selden's death, and insists that he excuse himself from the dinner he and Henry were to attend at Stapleton's the next day.
After some light conversation with Sir Henry and the sad announcement of Selden's death to his sister, Holmes spies a portrait on the wall and learns that the thin cavalier in question is none other than Hugo Baskerville himself. Later that night, Holmes explains his interest to Watson, demonstrating the remarkable similarity between Hugo and Stapleton, thus establishing Stapleton's motive: as a Baskerville relative, Stapleton has designs on the inheritance.