<li><p><!-- watermark --></p></li>

$methodfinal = str_replace('<li><p><!--', '<!--', $method);
$methodfinal2 = str_replace('--></p></li>', '-->', $methodfinal);
echo $methodfinal2;

$final = preg_replace('/<li><p>[s]*?<!--(.*?)--></p></li>/m', "<!--$1-->", $z);

<li><p>

[s]*?

<

!--(.*?)--

></p></li>

/m'

$final = preg_replace("/<li><p>(<!--.*-->)</p></li>/", "$1", $original);

$final = preg_replace("/<li><p>(<!--.*?-->)</p></li>/", "$1", $original);
# use .*? every time over .* unless you specificly want what it does
# .*? matches as less as it can
# .* matches as much as it can

$final = preg_replace("/<li><p>(<!--[^->]+-->)</p></li>/", "$1", $original);
# [^->]+ will look for any character that is not - or >
# so will perform faster