Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Yoga apparel maker lululemon athletica (NASDAQ:LULU) last reported earnings three weeks ago. That means it will report earnings again in less than three months' time. Investors should seriously consider buying Lululemon stock before that happens.

Or at least, that's what Merrill Lynch thinks. Here's what you need to know.

Lady doing yoga stretch

Lululemon's fiscal year enters its home stretch -- and Merrill Lynch enters a buy rating. Image source: Getty Images.

What Lululemon said this month

Three months ago, my Foolish colleague John Ballard lauded Lululemon's performance in fiscal Q2, a quarter in which the yoga-wear maker reported 13% sales gains, 7% growth in same-store sales, and a goal of reaching $2.6 billion in sales by year-end.

Three months later, fellow Fool Dan Caplinger confirmed that Lulu was well on its way to reaching that goal. In fact, sales growth accelerated in fiscal Q3, with revenue rising 14% and same-store sales up 8%. Direct-to-consumer sales jumped an incredible 26%, and those high-margin sales helped to push gross margin up to 52% for the quarter.

Encouraged by these results, management predicted it could book more than $2.6 billion in sales this year, and earn as much as $2.48 per share (pro forma).

Merrill Lynch becomes a fan

Sound good so far? This story could get even better. Today, analysts at Bank of America's Merrill Lynch division announced that, after examining the traffic trends, they're now prepared to raise their target price on Lululemon shares by more than 10%.

According to StreetInsider.com (requires subscription), Merrill Lynch observed "busy stores and long register lines" at Lululemon in the weeks prior to Christmas -- which in conjunction with the strong sales trends we've seen online, bodes well for the company's sales this holiday season. Moreover, Merrill noted that Lululemon was not advertising any "storewide promos" nor "discounts on popular core items" to explain all the extra traffic.

This lack of promotional activity suggests that the additional sales Lulu has been racking up will not come at the cost of profit margins. In fact, profits might grow even faster than sales if those sales were being made at full price.

What to expect when you're expecting Q4 results

According to data from analysts surveyed by S&P Global Market Intelligence, Wall Street is looking for Lululemon to report no more than $1.21 per share in GAAP net profit on sales of only $883 million when Q4 2017 results come out next year. Full-year sales are expected to approximate $2.6 billion, on which Lululemon should earn GAAP profits of $2.23 per share.

If Merrill Lynch's assessment of its first-hand observations turns out to be accurate, however, and assuming online sales hold up and supplement all the activity that Merrill saw taking place at the company's physical stores, then Q4 could turn out to be a real blowout of a quarter for Lululemon. Sales and earnings alike could exceed analyst expectations, and deliver an earnings surprise for Lululemon shareholders.

What it means to investors

Given all the above, it's no surprise to see Merrill doubling down on its buy recommendation on Lululemon stock, and raising its price target on the shares (to $89).

Granted, at more than 39 times trailing earnings, and with most analysts still forecasting only mid-teens long-term earnings growth for Lululemon stock, these shares remain pricey -- and they price in a lot of good news from the coming quarterly report. There's a real risk of their underperforming over the long term.

But if Merrill Lynch is right, there's also a very good chance that Lululemon stock will outperform in a big way when Merrill Lynch's Q4 predictions turns into Lululemon's confirmed Q4 profits.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends Lululemon Athletica. The Motley Fool has a disclosure policy.